What is Default Servicing?
This 4 minute video offers highlights from the below description of mortgage servicing.
The servicer works with individual homeowners to ensure that their payments are posted on time and disbursed appropriately, according to guidelines and requirements established by the investors, insurers, guarantors, and regulators. If the homeowner is making monthly payments on time, the servicer’s job is to credit the payments properly and distribute them to the relevant parties, often through escrow accounts.
Unfortunately, not all homeowners make their payments on time every month. A small percentage of homeowners have trouble paying their bills on time, and they pay a few days after their payments are due.
Sometimes, homeowners experience personal hardships such as illness, divorce, unexpected job loss, or a natural disaster that make timely payments difficult or impossible.
When homeowners fall behind on payments, they are considered delinquent and require personal assistance from their servicers. When the homeowner becomes delinquent or when default appears imminent, the borrower enters default servicing. Default servicing is often referred to as loss mitigation because the servicer’s ultimate goal is to minimize the losses of both the investor and the homeowner.
First step—communication. The first step in default servicing is to contact the homeowner and determine why a payment wasn’t made. Perhaps the homeowner forgot to make a payment or was late because of some other problem that is relatively easy to resolve.
Often, however, the problem is more complex and requires additional understanding and accommodation by the servicer. For instance, a borrower may have lost a job or experienced some other financial hardship, so they can’t catch up on their payments.
Second step—get back on track. The second step in default servicing is helping homeowners resume payments. Servicers may use various tools to help homeowners get back on track, including repayment plans, forbearances, and loan modifications.
A repayment plan gives a borrower a set period to bring a mortgage current by making regular monthly payments, plus an additional amount that will repay the delinquency.
In a forbearance, a homeowner’s monthly payments are temporarily suspended, usually for less than a year.
In a loan modification, the lender changes the homeowner’s monthly payment by altering the original mortgage terms. This could include reducing the interest rate, extending the length of time available to the homeowner to repay the loan, decreasing the principal balance on which interest is due, or even reducing the principal owed on the loan.
How does a servicer decide what options to offer the borrower?
The options depend on who owns, who guarantees and who insures the loan. Servicers are required by many – but not all - investors, insurers, guarantors, and regulators to offer some options, and they have limited discretion on whether to offer – or not offer -- others.
For loans held in a financial institution’s portfolio, the institution sets the options. For loans insured or guaranteed by Fannie Mae, Freddie Mac, the FHA, the VA, or the USDA, the insurer or guarantor sets the rules, and servicers have limited discretion as to what options to offer. For loans in private-label securitizations, servicers have more discretion than with government or GSE loans, but they are ultimately governed by the documents of that particular deal.
Because the relevant investors, insurers, guarantors, and servicers are unique for each mortgage, there is no single set of options that applies to all loans. In fact, neighbors with two identical mortgages and two identical hardships could have different assistance options available to them based on the guidelines established by their investor, guarantor, or insurer.
Generally, investors, guarantors, or insurers direct servicers to provide options to the homeowner to help the homeowner get back on track and avoid foreclosure when such options provide more financial benefit to the investor over time than foreclosing on the loan and selling the property. Foreclosure is expensive. The costs of foreclosure are considerable, and, at the end of what can be a long process, the home normally sells at a discount to its fair market value. Thus, it is in the interest of the investor, insurer, and servicer to give the borrower the opportunity to get back on track if possible.
Third step—when getting back on track fails. If a homeowner cannot make adequate monthly mortgage payments or can no longer afford the home, the next step in default servicing is for the servicer to transfer ownership of the home to the mortgage holder in accordance with the servicer’s contract with the investor, guarantor, or insurer.
There are several tools for transferring ownership. Two of the most common are the short sale and the deed in lieu of foreclosure.
Short sale. If the lender and borrower agree, the homeowner can sell the home for less than what is owed on the mortgage. In some cases, the lender or investor will also forgive the additional amount owed, though not always.
Deed in lieu of foreclosure. Here, the homeowner transfers the property deed to the lender in return for a release from having to pay the rest of the mortgage.
Foreclosure. If these options fail, a foreclosure action begins in accordance with the servicer’s contract with the investor, guarantor, or insurer. In a foreclosure, the mortgage holder takes possession of the house and usually sells the property and keeps the proceeds to offset the losses. The servicer’s job is to initiate the foreclosure and follow it through until the property is auctioned off. If the homeowner has not vacated the property by the time the foreclosure is completed, the servicer will begin an eviction.
Property preservation. Another aspect of default servicing occurs after the homeowner vacates the property or after the foreclosure sale. In either case, the servicer is responsible for maintaining the property until it can be returned to the investor or insurer. Property preservation may include adhering to municipal ordinances on property maintenance, securing the property to fend off trespassers, overseeing any necessary repairs, winterizing the property, managing monthly maintenance such as lawn care, and addressing any legal issues, such as property liens, to produce a clean property title.
Default servicing ends once the servicer has conveyed the property to a third party, the investor, or the insurer.
For additional information on mortgage servicing, visit these pages: