Borrowers Should Be Able to Fire Mortgage Servicers
February 2, 2004

"I'm very unhappy with the lender servicing my mortgage, would you spell out the procedures for changing lenders?"

Bad news, the only way to change the lender servicing your loan is by refinancing. Unless you have other reasons to refinance, that is a costly way to get a new lender, especially when you have no way of knowing that the new one will be better than the old one. There should be a better way, and I will suggest one below.

With some exceptions, the quality of servicing ranges from poor to abysmal, for reasons that are no secret. The financial incentives to provide good service to customers, which work in other sectors of our economy, don’t work for loan servicing. The firm servicing mortgages will not get more customers by improving service quality, only higher costs. And the firm providing minimal service or less will not lose customers, because their customers are locked in.

While this problem has been around for some time, the development of the sub-prime market in the 90s raised the stakes significantly. Sub-prime borrowers, unable to meet traditional underwriting requirements, became a profitable source of business at higher prices than those paid by prime borrowers.

Mortgage credit thus became available to a group that had previously been excluded from the market, which was a plus. Unfortunately, this group was also highly vulnerable to a number of sharp practices that left some worse off than if they had never borrowed. These practices came to be called "predatory lending."

Sub-prime loans had to be serviced, and some of the firms doing the servicing adopted practices as outrageous as those used by predatory loan originators. Here are some:

*They purchased overpriced homeowners’ insurance, even though the borrower already had a policy, and paid for it by increasing the borrower’s balance so it would not be noticed for a period, if ever.

*They failed to credit borrowers for extra payments.

*They held scheduled payments past the grace period before posting them, thus collecting late fees.

*They imposed prepayment penalties on borrowers who were refinancing, even though the notes stated that there was no such penalty.

*They failed to report good payment history to the credit reporting bureaus, thus preventing borrowers from improving their credit scores.

*The statements provided borrowers were late, and so poorly designed that even an expert found them incomprehensible, thus making it difficult for borrowers to detect their shenanigans.

Predatory servicing is even easier to get away with than predatory lending, since the customer has already been landed and has no place to go.

While numerous legislative and regulatory actions have been taken at the Federal and state levels to curb predatory lending, predatory servicing has been relatively immune until recently. In a much-publicized action last year, the Federal Government sued Fairbanks Capital Corporation for a series of practices similar to those cited above, and won an injunction against continuation of the practices, along with a $40 million fine.

Such suits are useful but won’t stop predatory servicing because there is too much money to be made. Predatory servicing won’t go away until it starts resulting in lost customers. That will happen when borrowers are empowered to select another lender to service their loan.

I estimate there are roughly 38 million homeowners who have a long-term relationship with a servicing agent that they did not choose. Their loan provider was either a mortgage broker, or a lender who subsequently sold the servicing. These borrowers should be empowered to opt out.

To avoid undue disruption and encourage rational decisions, the opt-out option should become effective only after (say) 6 months of servicing, and should apply only once. If the servicing agent is changed, however, the borrower should receive a new opt-out option, exercisable after 6 months with the new servicer.

If borrowers have the right to opt out, many firms with servicing capacity will vie for the privilege of serving them. The stream of income generated by servicing contracts has value. Ordinarily, these contracts must be purchased for anywhere from 1/2% to 2% or more of the balance. An opt-out contract would be free.

To win the favor of opt-outs, servicers would be obliged to compete. Since servicers are paid by lenders rather than by borrowers, they will compete with service, which is exactly what is needed. Firms with efficient and courteous support people, short waits, easy-to-read statements, etc., will draw opt-outs from firms that have served them badly. The market would, at long last, begin to work for the borrower.
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