Loan Servicers, the Lesser-Known Predators

In recent years, there has been a flurry of proposals and legislation directed against predatory mortgage lending. The focus, however, has been almost entirely on loan originations.

Aside from a few well-publicized lawsuits, predatory servicing has attracted little attention. In many respects, though, it is more vicious and the adverse consequences more far-ranging.

The loan-origination market is a minefield for borrowers, but they have choices. Exercising intelligence and care, and with a little homework, they can find loan providers that will treat them fairly. When a loan is closed and shifted to a servicing agent, however, the borrower's choices disappear.

Borrowers have no say in choosing the firms that service their loans. They cannot fire that firm for cause, no matter how wretched the service. The only way they can extricate themselves from predatory servicers is to refinance. That is costly, and there is no assurance that subsequent servicers will be better.

The financial incentives to provide good service to customers, which work in other sectors of our economy, work only selectively with loan servicing. Servicers that originate loans have an incentive to provide good service to borrowers they view as potential clients for new loans or other services. The incentive disappears, however, for borrowers with spotty payment records.

Absolutely no incentive for good service exists for specialized servicing firms that have nothing to sell. Such firms will not get more customers by improving service quality, only higher costs; nor will they lose customers if they provide poor service. Their incentive is to generate as much revenue as possible from borrowers. It is hardly surprising that such firms figure so prominently in discussions of predatory servicing.

Predatory servicing could be reduced or eliminated by legislation that restricts the sale of servicing contracts or gives borrowers the right to change servicers. Those would be drastic changes that would be difficult to enact. The alternative is to identify predatory practices and make them illegal. Here are some practices servicers should be required to follow, and why:

¿ Mandatory provision of complete and comprehensible monthly statements: The law should require servicers to provide easy-to-understand monthly statements showing everything that affects a borrower's account. They should include balance changes and their sources, payments, disbursements, rate adjustments and fees.

Rationale: In the absence of comprehensible monthly statements, predatory practices can go unnoticed by borrowers indefinitely.

¿ No suspension of payments because of escrow shortages: Servicers should be prohibited from placing scheduled payments of principal and interest in suspense accounts when only escrow payments are short.

Rationale: This pernicious practice results in unnecessary delinquencies and late payments and can lead to collections and foreclosure.

¿ No profits from loans in collection: On services purchased from third parties in connection with loans in collection, such as legal fees and property inspections, servicers should be barred from marking up third-party fees, receiving payments for referral of business or purchasing the services from affiliated entities.

Rationale: Profiting from loans in collection provides an incentive to move borrowers to that status unnecessarily. It also increases the cost to borrowers struggling to return to good standing by paying back arrears.

¿ Mandatory reporting to credit bureaus: Servicers should be required to report payment history on all their accounts.

Rationale: Servicers should not be able to cripple the ability of borrowers to refinance favorably by not reporting good payment records to the credit bureaus.

¿ No conversions to simple interest: On purchased servicing contracts, the servicers should not be permitted to convert mortgages to simple interest merely because notes do not explicitly prevent it.

Rationale: Simple-interest mortgages, which accrue interest daily, are problematic for many borrowers. If a borrower did not negotiate a simple-interest mortgage at origination, a later conversion to simple interest after the transfer of servicing is unconscionable.

¿ Mandatory disclosure of policy toward crediting extra payments: Servicers should disclose exactly what their procedures are for crediting extra payments to loan balances.

Rationale: Borrowers making extra payments of principal have the right to this information so that they can plan their schedule of extra payments in the most advantageous way.

¿ Mandatory retention of complete servicing files: Servicers should be required to retain complete files on all accounts until they are paid off. When servicing is transferred to new servicers, the purchasing firms should be required to obtain the complete files.

Rationale: Servicers should be prevented from covering up abusive practices by selling the servicing while leaving evidence of the abuses behind.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,http://www.mtgprofessor.com.

Copyright 2007 Jack Guttentag

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