How Do Mortgage Servicers Make Money? A Comprehensive Guide

Mortgage servicers play a crucial behind-the-scenes role in the home lending industry. But how exactly do these companies turn a profit? In this comprehensive guide, we’ll demystify mortgage servicing and break down the key ways servicers generate revenue.

What Is a Mortgage Servicer?

A mortgage servicer is a business that takes care of the day-to-day management and administration of mortgage loans. Servicers act as intermediaries between borrowers and investors. Their key responsibilities include:

• Collecting monthly mortgage payments
• Maintaining escrow accounts and paying property taxes and insurance
• Sending account statements and paperwork to borrowers
• Distributing payments to mortgage investors
• Overseeing foreclosures and loan modifications

In essence, servicers take care of all the grunt work associated with mortgage loans after they are originated. This frees up lenders to focus on their core business – originating new loans.

Now let’s look at the main ways mortgage servicers generate income from this administrative work.

1. Servicing Fees

The primary source of revenue for servicers is servicing fees. These fees are typically expressed as a percentage of the outstanding principal balance of the mortgages in a servicer’s portfolio.

Servicing fees range from 0.25% to 0.50% per year. So for a $200000 mortgage the servicer would earn between $500 to $1000 annually in servicing fees. These fees are collected monthly, so the servicer earns 1/12th of the annual fee each month.

Servicers collect higher fees for riskier loans with lower credit scores. Subprime loans often have servicing fees of 0.50% or more. Meanwhile, prime conventional loans with good credit can have fees as low as 0.25%.

2. Float Income

Mortgage servicers collect payments from borrowers at the beginning of each month but may not remit them to investors until weeks later During this time, the servicer can invest the accumulated payments and earn interest income – known as float income

For large servicers with tens of billions worth of monthly payments, even a small amount of float income can add up to significant profits.

3. Ancillary Fees

Servicers earn various ancillary fees and charges in the normal course of mortgage administration:

• Late fees – Typically around 5% of the monthly payment amount, charged when borrowers pay after the due date.

• Modification fees – Fees for processing loan modifications, forbearances, or repayment plans for delinquent borrowers.

• Convenience fees – Charges for online payments, expedited payments, or over-the-phone payments.

• Prepayment penalties are fees that people have to pay when they pay off their mortgage early or switch lenders.

These many small fees can add up to a big profit center, especially when the economy is bad and more people fall behind on their payments.

4. Mortgage Servicing Rights (MSRs)

Mortgage servicing rights, or MSRs, are things that servicers get in exchange for taking care of a group of loans. Servicers can buy and sell MSRs, just like they can buy and sell loans.

When mortgage rates decline, existing MSRs become more valuable because borrowers are less likely to prepay or refinance their mortgages. Servicers can then sell the rights at a profit.

Conversely, when rates rise, prepayments accelerate, decreasing the value of MSRs.

5. Interest on Escrow Accounts

Servicers collect borrowers’ property tax and insurance payments into escrow accounts before disbursing them annually or semi-annually. Until those payments are made, the funds sit in the servicer’s accounts earning interest.

While not a primary profit driver, any interest earned contributes incrementally to a servicer’s bottom line.

The Controversial Nature of Servicing Compensation

The servicing fee structure has attracted controversy over the years. Critics argue it incentivizes some negative servicer behaviors:

• Disincentives to help borrowers build equity and pay off loans faster.
• Perverse incentives to drag out or avoid loan modifications.
• More incentives to foreclose than facilitate alternative options.

Reform advocates have called for changes to the servicer compensation model to better align with positive borrower outcomes. But the industry maintains the current model is necessary to compensate servicers for the effort and risks involved.

Key Takeaways: How Mortgage Servicers Generate Revenue

• Main source of income is servicing fees charged as a percentage of outstanding loan balances.
• Additional revenue streams from float income, ancillary fees, mortgage servicing rights sales, and interest on escrow accounts.
• Compensation structure controversial due to disincentives perceived to harm borrowers.
• Reforms proposed but fiercely resisted by the industry.

Understanding how mortgage servicers make money provides key insights into this little-understood sector critical to housing finance in America. Appropriate compensation balances the needs of borrowers, servicers, and investors – but striking that balance remains an ongoing debate.