Protecting Borrowers Against Predatory Servicing
December 18, 2006
Recent years have seen a flurry of proposals and legislation directed toward predatory mortgage lending. The focus, however, has been almost entirely on loan originations. Aside from a few well-publicized law suits, predatory servicing has attracted little attention, yet in many respects it is more vicious, and the adverse consequences are more far-ranging.
The loan origination market is a minefield for borrowers, to be sure, but they do have choices. Exercising intelligence and care, and with a little homework, they can find a loan provider who will treat them fairly. When the loan is closed and shifted to a servicing agent, however, the borrower’s choices disappear.
Borrowers have no say whatever in choosing the firm that will be servicing their loan. They cannot fire that firm for cause, no matter how wretched the firm’s service. The only way they can extricate themselves from a predatory servicer is to refinance, which is costly, with no assurance that the next servicer will be better.
The financial incentives to provide good service to customers, which work in other sectors of our economy, work only selectively with loan servicing. Servicers who originate loans have an incentive to provide good service to those borrowers they view as potential clients for new loans or other services. The incentive disappears, however, for borrowers with spotty payment records, who are not viewed as potential customers for other services.
An incentive to provide good service doesn’t exist at all for specialized servicing firms who have nothing to sell. Such firms will not get more customers by improving service quality, only higher costs, nor will they lose customers if they provide poor service. Their incentive is to generate as much revenue as possible from borrowers. It is hardly surprising that such firms figure so prominently in discussions of predatory servicing. See Why Is Mortgage Servicing So Bad?
Predatory servicing could be reduced or eliminated by legislation that restricted the sale of servicing contracts, or gave borrowers the right to change servicers. See Borrowers Should Be Able to Fire Mortgage Servicers. These would be drastic changes that would be very difficult to enact. The alternative is to identify predatory practices and make them illegal. Here is a partial list.
The law should require servicers to provide easy-to-understand monthly statements showing everything that transpired during the month that affected the borrower’s account. This should include balance changes and their sources, payments, disbursements, rate adjustments, and fees.
Rationale: In the absence of comprehensible monthly statements, predatory practices can go unnoticed by the borrower indefinitely. See Should All Borrowers Receive Monthly Statements?
Servicers should be prohibited from placing scheduled payments of principal and interest in suspense accounts when only the escrow payment is short.
Rationale: This pernicious practice results in unnecessary delinquencies and late payments, and can lead down a slippery slope to collections and ultimate foreclosure. See Escrow Abuse and Manufactured Foreclosures.
On services purchased from third parties in connection with a loan in collections, such as legal fees and property inspections, servicers should be barred from marking up third party fees, receiving payments for referral of business, or purchasing the services from affiliated entities.
Rationale: Profiting from loans in collections provides an incentive to move borrowers to that status unnecessarily. It also increases the cost to borrowers struggling to return to good standing by paying back arrears.
Servicers would be required to report payment history on all their accounts.
Rationale: Servicers should not be able to cripple the ability of borrowers to refinance profitably by not reporting good payment records to the credit bureaus.
On purchased servicing contracts, the purchasing servicer should not be permitted to convert a mortgage to simple interest merely because the note does not explicitly prevent it.
Rationale: Simple interest mortgages, which accrue interest daily, are more problematic for most borrowers than standard monthly accrual mortgages. (See Simple Interest Mortgages: A Trap For the Unwary). If a borrower did not negotiate a simple interest mortgage at origination, a later conversion to simple interest following the transfer of servicing, is unconscionable.
Servicers should disclose exactly what their procedures are for crediting extra payments to the loan balance.
Rationale: Borrowers making extra payments of principal have the right to this information so that they can plan their schedule of extra payments in the most advantageous way.
Servicers should be required to retain the complete file on every account until it is paid off. When servicing is transferred to a new servicer, the purchasing firm should be required to obtain the complete file.
Rationale: Servicers should be prevented from covering up abusive practices by selling the servicing to another firm while leaving evidence of the abuses behind.
Recent years have seen a flurry of proposals and legislation directed toward predatory mortgage lending. The focus, however, has been almost entirely on loan originations. Aside from a few well-publicized law suits, predatory servicing has attracted little attention, yet in many respects it is more vicious, and the adverse consequences are more far-ranging.
The loan origination market is a minefield for borrowers, to be sure, but they do have choices. Exercising intelligence and care, and with a little homework, they can find a loan provider who will treat them fairly. When the loan is closed and shifted to a servicing agent, however, the borrower’s choices disappear.
Borrowers have no say whatever in choosing the firm that will be servicing their loan. They cannot fire that firm for cause, no matter how wretched the firm’s service. The only way they can extricate themselves from a predatory servicer is to refinance, which is costly, with no assurance that the next servicer will be better.
The financial incentives to provide good service to customers, which work in other sectors of our economy, work only selectively with loan servicing. Servicers who originate loans have an incentive to provide good service to those borrowers they view as potential clients for new loans or other services. The incentive disappears, however, for borrowers with spotty payment records, who are not viewed as potential customers for other services.
An incentive to provide good service doesn’t exist at all for specialized servicing firms who have nothing to sell. Such firms will not get more customers by improving service quality, only higher costs, nor will they lose customers if they provide poor service. Their incentive is to generate as much revenue as possible from borrowers. It is hardly surprising that such firms figure so prominently in discussions of predatory servicing. See Why Is Mortgage Servicing So Bad?
Predatory servicing could be reduced or eliminated by legislation that restricted the sale of servicing contracts, or gave borrowers the right to change servicers. See Borrowers Should Be Able to Fire Mortgage Servicers. These would be drastic changes that would be very difficult to enact. The alternative is to identify predatory practices and make them illegal. Here is a partial list.
Mandatory Provision of Complete and Comprehensible Monthly Statements
The law should require servicers to provide easy-to-understand monthly statements showing everything that transpired during the month that affected the borrower’s account. This should include balance changes and their sources, payments, disbursements, rate adjustments, and fees.
Rationale: In the absence of comprehensible monthly statements, predatory practices can go unnoticed by the borrower indefinitely. See Should All Borrowers Receive Monthly Statements?
No Suspension of Payments Because of an Escrow Shortage
Servicers should be prohibited from placing scheduled payments of principal and interest in suspense accounts when only the escrow payment is short.
Rationale: This pernicious practice results in unnecessary delinquencies and late payments, and can lead down a slippery slope to collections and ultimate foreclosure. See Escrow Abuse and Manufactured Foreclosures.
No Profits From Loans in Collection
On services purchased from third parties in connection with a loan in collections, such as legal fees and property inspections, servicers should be barred from marking up third party fees, receiving payments for referral of business, or purchasing the services from affiliated entities.
Rationale: Profiting from loans in collections provides an incentive to move borrowers to that status unnecessarily. It also increases the cost to borrowers struggling to return to good standing by paying back arrears.
Mandatory Reporting to Credit Bureaus
Servicers would be required to report payment history on all their accounts.
Rationale: Servicers should not be able to cripple the ability of borrowers to refinance profitably by not reporting good payment records to the credit bureaus.
No Conversions to Simple Interest
On purchased servicing contracts, the purchasing servicer should not be permitted to convert a mortgage to simple interest merely because the note does not explicitly prevent it.
Rationale: Simple interest mortgages, which accrue interest daily, are more problematic for most borrowers than standard monthly accrual mortgages. (See Simple Interest Mortgages: A Trap For the Unwary). If a borrower did not negotiate a simple interest mortgage at origination, a later conversion to simple interest following the transfer of servicing, is unconscionable.
Mandatory Disclosure of Policy Toward Crediting Extra Payments
Servicers should disclose exactly what their procedures are for crediting extra payments to the loan balance.
Rationale: Borrowers making extra payments of principal have the right to this information so that they can plan their schedule of extra payments in the most advantageous way.
Mandatory Retention of Complete Servicing Files
Servicers should be required to retain the complete file on every account until it is paid off. When servicing is transferred to a new servicer, the purchasing firm should be required to obtain the complete file.
Rationale: Servicers should be prevented from covering up abusive practices by selling the servicing to another firm while leaving evidence of the abuses behind.