On May 24th, The New York Times ran an article in their Opinion section that revealed a nasty, little-known truth about loan servicing that I find outrageous.

As most homeowners know, your mortgage is probably not owned or serviced by the bank or company from whom you originally borrowed.  Not only was your loan probably sold in the secondary market, but it is likely that it is serviced by an entirely different company than the bank or company you actually owe. 

Loan servicing refers to the tasks associated with collecting your monthly payment, paying the investor, and often times, managing payments for insurance and property taxes.  These servicers are also responsible for sending out notices associated with delinquencies, collection activities, and if needed managing defaults.  In return, the servicer is paid a percentage of the principal amount owed, usually 12.5 – 50 basis points (1bp = 0.01%).  Additionally, the flat servicing fee may be augmented with a variety of incentives, all designed to create additional cash flow from each loan on the books.  The total value of these fees and incentives are noted on the servicer’s balance sheet as MSRs – Mortgage Servicing Rights.

Now here is the kicker:  Banks make more from the fees and charges associated with managing a defaulted loan and foreclosure than they can make on a loan modification!  Surprised?  No wonder so few modifications are approved; the servicers have their MSRs to protect! 

The only winners in this game are the servicers.  Not only do the homeowners seeking a modification lose, but so do the banks and investors who will foot the high cost of foreclosures and carrying REOs. 

Luckily, there are others that find this behavior unacceptable.  Democrats Jack Reed and Sheldon Whitehouse of Rhode Island and Sherrod Brown of Ohio have introduced Senate bills to establish standards for the loan servicing industry.  The proposed laws and regulations are designed to prevent banks from putting their financial interests above those of everyone else.

Here are 3 suggested new rules: 

1)      Homeowners would be evaluated for loan modification before ANY foreclosure activity, or related fee is initiated.

2)      Lender analysis used to approve or reject loan modifications would be standardized and public.

3)      Should a lender fail to offer a modification when analysis indicates that one is warranted the lender would be blocked from proceeding with foreclosure.

Whether it is the result of a Senate Bill, or actions by the new Consumer Financial Protection Bureau, someone needs to rein-in the greed of the loan servicing industry and give borrowers a much-needed break.

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