This is another mortgage concept agents should understand: Servicers vs. Mortgage Note Holders – what’s the difference?
About 20% to 30% of mortgages are portfolio loans, meaning they are still held by the lender that loaned the money.
This is the case with most jumbo loans. Big banks like Citi, Wells, B of A, and Chase will retain their loans in their portfolios and also retain the “servicing.”
Loan servicing is the process of managing a loan after it funds. This includes collecting borrower payments, managing escrow accounts, handling customer inquiries, and addressing delinquencies and defaults.
Currently, some 70% to 80% of mortgages are not held in portfolios, as they are “securitized.”
Almost all conforming (Fannie/Freddie) loans are securitized, meaning they are “pooled” with other mortgages and sold on the secondary market as mortgage-backed securities, or MBS.
This is where things get confusing.
Who owns the servicing rights, and who owns the mortgage or holds the promissory note?
About 80% of mortgages are serviced by firms that own the servicing rights but do not own the mortgage or hold the note.
When the movie “It’s A Wonderful Life” was made in 1946, almost all loans were portfolio and serviced by the noteholder.
This dynamic started to change in the 1970s when securitization first started, but things really changed in the 1980s and 1990s.
Why Would a Firm Want to Hold the Servicing Rights?
I. The primary reason is to make money from the servicing fees – which range from about 0.25% of the loan to as much as 0.50% annually.
So, a $100,000 loan might generate $250 to $500 per year of servicing fees, or about $21 to $42 per month (more often it’s the lower amount).
Given all the manpower and tech required to properly service a loan, that is not much. So, many servicers operate at a very large scale to foster enough efficiencies to make money.
The efforts to keep costs at a minimum are also why customer servicing is sometimes lacking.
II. The other reason an entity might buy servicing rights is for the marketing and refinance possibilities.
This is why some jumbo lenders offer such low rates in fact.
They use the servicing relationship as an opportunity to market other bank products, like checking accounts and HELOCs.
Other firms, like Freedom Mortgage for example, will pay a premium for service rights because they are also a lender and they intend to market to those borrowers very aggressively if/when refi opportunities pop up.
SIDEBAR: We often sell our loans to Freedom for that premium, well aware that they will market to our borrowers. Knowing this, though, we market to those borrowers much more aggressively to ensure they come back to us, making Freedom’s premium a waste of money for poor Freedom (don’t tell them though 😊).
Why Do Mortgage Banks Sell Servicing Rights Instead of Keeping Them to Earn Money?
We sell the servicing rights because it is lucrative, and because we don’t want to manage a servicing company.
We can get anywhere from 0.5% to 1.5% of the loan amount for servicing rights.
So, for a $500,000 loan, for example, we’d rather get $5,000 up front as opposed to earning $100 per month servicing it – less the substantial overhead required to do that servicing.
How Do Mortgage Banks Sell Servicing Rights?
Sometimes we sell loans directly to Fannie Mae and Freddie Mac – and those investors do NOT service loans. So, we then have to sell the servicing for those loans separately to servicers.
More often though we sell loans along with the servicing rights to investors like Freedom Mortgage (mentioned above), PennyMac, Mr. Cooper, or Chase.
Investors will pay more or less for servicing depending on the amount of the fees and/or the likelihood that the borrower will hold the loan for a long time (servicing rights for loans with very low rates are worth more because it is likely those loans won’t be paid off soon).
But, as explained above, some investors will still pay premiums for higher rate loans too – if they think they can capture the refinance.
Acquaintances Had $500,000 per Month of Servicing Fees
I have some acquaintances who own a small mortgage company and they retained all of their servicing rights during COVID.
It was smart because it generated decent cash flow after rates increased.
But servicing overhead eats up much of that cash, those loans are now paying off, and the company largely stopped originating (because they had the servicing income), so they are now trying to figure out how to fire up originations again in a vastly changed market (and it’s not going well).
All this is to say that you can live by servicing and die by servicing.
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