Most knowledgeable observers of the mortgage-servicing industry agree that we are long overdue for reforms to this critical piece of the homeownership process. According to speakers at a recent panel discussion cohosted by the Urban Institute and CoreLogic, we must address the high cost of servicing, improve the experience of borrowers, evaluate stronger regulatory oversight of new players, and promote innovation and competition. We must also reassess the method of paying servicers for their work given that the flat rate, which has been in use for three decades, is grossly misaligned with the actual cost of servicing mortgages. There may not be consensus on the details, but most agreed that the consequences of further delay could be severe.
Faith Schwartz of Housing Finance System Strategies moderated a data-focused discussion that highlighted the urgency of reforming servicing.
An example of reforming compensation
Mortgage servicers perform all the processing work after a borrower takes out a mortgage, including sending monthly statements, collecting and remitting monthly mortgage payments to investors, and working with borrowers with delinquent or “nonperforming” loans. The inadequacy of the current compensation model illustrates the need for reform. Under the current compensation structure, which has been in place since the 1980s, servicers are paid a flat 25 basis point fee for conventional mortgages. According to Housing Finance Policy Center codirector Laurie Goodman, “this regime pays servicers too much for servicing performing mortgages and too little for servicing nonperforming ones.”
Data from the Mortgage Bankers Association show that the average cost to service a performing mortgage was only $181 per loan in 2015 but was $2,386 for a nonperforming loan—roughly 13 times more. In addition, the cost to service both performing and nonperforming loans has trended up over the last eight years. Voicing his support for servicer compensation reforms, Bipartisan Policy Center fellow Michael Stegman underscored “the need to align incentives with the escalating costs of servicing nonperforming loans.”
But the skyrocketing cost of servicing nonperforming loans is only part of the problem. The cost of servicing nonperforming loans “can be highly unpredictable” because delinquent borrowers “need personalized help,” according to Raghu Kakumanu, senior vice president at Wells Fargo. This means servicers cannot reasonably estimate how many loss-mitigation actions, how much time, how many resources, and how much money it will take to reinstate a nonperforming loan or see it through to foreclosure. This uncertainty is further exacerbated by complex and cumbersome loss-mitigation procedures, especially for Federal Housing Administration–insured mortgages.
Why does this matter? Because the exorbitant and unpredictable cost of servicing nonperforming loans gives lenders a strong reason to avoid lending to borrowers who have even a slight probability of default. And more often than not, these tend to be low- and moderate-income borrowers. Put simply, the current servicer compensation model is a significant contributing factor to tight credit for those without pristine credit scores.
The time is now
In September 2011, the Federal Housing Finance Agency (FHFA) released a detailed discussion paper for public comment in an effort to reform servicer compensation. This paper discussed two options. The first is a “reserve account” model that would require a portion of servicing income to cover the cost of servicing nonperforming loans. The second is a “fee-for-service” model that would pay servicers a set dollar fee for servicing performing loans and an incentive compensation tied to positive actions or outcomes for nonperforming loans.
But the FHFA had to defer further action on this effort for several reasons. First, the mortgage market was too fragile in 2011, and the industry was too busy addressing delinquencies to take up any major reforms. Second, servicers “had their hands full trying to keep up with evolving loan-modification programs,” according to Ed DeMarco, senior fellow at the Milken Institute and former acting director of the FHFA. And finally, there was lack of clarity on “what the servicing rules and requirements were going to look like going forward,” said DeMarco.
None of these reasons is relevant today. The mortgage market is stronger, house prices are rising, and delinquencies and modifications are approaching precrisis levels. In fact, the housing market has not only stabilized, but has improved significantly since 2011. In addition, the Consumer Financial Protection Bureau (CFPB) finalized its servicing rule three years ago, giving servicers greater regulatory certainty. The CFPB has continued to fine-tune these requirements, with a recent update adding several “clarifications” and “clean ups” that servicers requested, according to Laurie Maggiano, program manager at the CFPB.
The risks of the status quo
Perhaps the most important reason to move forward on these reforms is the high cost of inaction. The status quo puts us on a path to continued increases and volatility in servicing costs, tighter credit for low- and moderate-income borrowers, and increasing safety and soundness risks posed by the growing role of nonbanks. The status quo also leaves in place barriers that stifle competition and discourage technological innovations that might help reduce servicing costs or improve customer service.
There will always be a reason to avoid this debate. But the challenges—and potential opportunities—presented by reforming servicing are simply too crucial to kick the can down the road. It is time we reengage.