Are These Mortgage Late Fees Kosher?
November 24, 2000

"I am a mortgage broker who arranged a loan for a client who made a monthly payment on the 16th of the month - one day after the grace period. Without notice, the lender imposed a late charge on that payment, and then proceeded to collect that charge by deducting it from the following month’s payment. That payment was made on time but recorded as late because of the deduction of the late charge from the previous month, which generated still another late charge. Seven consecutive payments were made on time but recorded as late because of the deduction of late charges on the prior payments. What can I do for this borrower?"

You have already done something by championing his cause well past the point where you had any financial interest in his case. Not all mortgage brokers would bother.

Start with a lecture about the importance of disciplined payments habits. Most mortgage contracts offer borrowers a 15-day grace period, with a late charge of 5% on payments received after the 16th.

On a 8% 30-year mortgage, a borrower who makes every payment on the 16th day will pay a true rate of about 7.97% because of the 15 days of grace every month. The borrower who makes every payment on the 17th with a 5% penalty will pay about 8.49%. That’s a heavy price for being careless.

But your client’s sloppiness is no excuse for the vicious trick played on him. Not only does it extract more late fees but it also blackens your client’s credit record.

The game is motivated by the economics of loan servicing. In recent years, servicing has become an increasingly specialized activity. Many firms originate few or no loans, but purchase servicing contracts as an investment. Even among firms that both originate and service loans, servicing is viewed as a profit center that must justify itself by earning a target rate of return.

The investment in servicing is what a specialized servicer pays for it, or what an originating firm that retains the servicing could have sold it for.

For example, lets say a firm pays $1 million for the right to service a loan portfolio of 1,000 loans with total balances of $100 million. The portfolio has an estimated average life of 7 years. The servicing fee on the $100 million is .25%, which generates income of $250,000 a year. It only costs the firm $50 a year to service each loan, or $50,000 in total. Net income is thus $200,000 a year for 7 years. The rate of return on investment is 9.20%.

Now add late charges, which by industry practice are retained by the servicing agent. If a late charge of 5% of the payment is collected from just 1% of the borrowers, the rate of return on the investment in servicing jumps almost to 10%. If late charges can be collected from 5% of the borrowers, the rate of return exceeds 12%.

The servicer’s interest in late fees doesn’t justify playing obscene games with borrowers. Check whether state law permits the servicer to collect the late charge from the monthly payment. I doubt they would if it is illegal, because it would expose them to costly class action suits.

Assuming the servicer is acting within the law, advise your client to pay the late fees. Then he can suggest to the lender that if the so-called late payments are taken off his credit record, he won’t tell his story to the press.

Readers should not conclude that the practice described above is widespread. I discussed this with Terry Klein, CEO of First Nationwide Mortgage, one of the largest mortgage-servicing firms in the country. His view is that the practice is much less common than it used to be. His firm and most other large servicers increasingly view mortgage borrowers as potential customers for other products, such as refinancing and home equity lines. Irritating customers with unfair late fees is not a good way to sell them other products.
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