In the mortgage industry, it's very rare that the loan originator, the company that created the note and mortgage, is the one that collects the mortgage payments directly from the borrower. Instead, the task of collecting mortgage payments and mortgage-related payments is transferred to a third party servicing company through mortgage servicing rights. Learn what mortgage servicing rights are, how they're used in real estate, and why it's important to understand this topic as a real estate investor.
What are mortgage servicing rights?
Mortgage servicing rights are a contractual agreement between a licensed servicing company and a loan originator that transfers the right to collect a debt from the lender to the servicing company. The servicing company is then responsible for the management of the loan, which can include:
- Collecting monthly mortgage or escrow payments.
- Allocating principal and interest from each payment to the loan balance.
- Collection and disbursement of property insurance or taxes collected in escrow.
- Reporting and sending monthly statements or notices to the borrower.
- Handling loss mitigation if the loan defaults.
The lender pays a monthly fee for the services provided by the servicing company, and the servicing company transfers all collected payments to the lender after it's collected and recorded in their system.
How are mortgage servicing rights used in real estate?
Mortgage servicing rights are almost exclusively used among top-level banks and lending institutions, many of which will have their own department that handles mortgage servicing for the lending institution as a separate branch or arm of company operations. Doing so allows the opportunity to service other loans created from other lending institutions, earning a fee for the company for their service. It also can streamline the sale of mortgage securities on the secondary market. For example, if Wells Fargo (NYSE: WFC) packages and sells a pool of mortgage-backed securities to PennyMac (NYSE: PMT) even though the lender has changed hands, the loan could potentially continue to be serviced by the same company, minimizing confusion with the borrower because of a loan-servicing transfer.
Mortgage servicers are required to follow very strict guidelines and regulations relating to the right to collect a debt. Transferring these servicing rights reduces some risk relating to collecting a mortgage or debt from the original lender and allows the lending institution to focus on creating new loans rather than managing the loans in their portfolio.
Why it's important for investors to understand
As an investor it's important to understand how the mortgage industry operates and why you might see a different company name in correspondence to a mortgage you may have on an investment property. It's also helpful to understand how the mortgage servicing arm of a mortgage real estate investment trust (REIT) or real estate stock is able to collect fees from servicing loans. If you personally invest in mortgage notes or decide to use owner financing to sell a property, you will need to decide if you want to transfer your mortgage servicing rights to a third party company for a small fee.
As you can see, mortgage servicing rights are actually very straightforward and extremely prevalent in the real estate industry for both residential and commercial loans. Understanding how they work will hopefully make you be a more informed consumer and investor in the future.