This post will take a look at situations where mortgage servicers screw up and why they screw up. I’ll let you decide whether or not they are “evil” and whether or not they deserve their bad press and regulatory attention.
Why mortgage servicers screw up
- They have to keep their expenses down.
- They are incentivized to get rid of defaulted mortgages as quickly as possible.
- Incompetence. Many mortgage servicers are disorganized.
- Many mortgage servicers have been understaffed because the mortgage servicing industry did not anticipate the huge wave of foreclosures from the US subprime crisis.
- Lack of experienced employees due to the massive growth in foreclosures and high churn rates.
- MSR transfers. Whenever servicing is transferred from one company to another, it is likely that homeowners will be lost in the shuffle. A loan modification that is in process may not be honored by the new servicer. Or, a loan mod may get lost. Differences in IT platforms may make the underwriting for a loan modification difficult.
- Mortgage servicing is complicated. Many MBS securitizations have different types of mortgages with different terms, especially if the mortgages came from different originators. Some MBS contain unusual mortgage types such as option ARMs with teaser rates. Each state has its own laws regarding mortgages and foreclosures. Each securitization has different rules about what the servicer can and cannot do.
Some people accuse mortgage servicers of intentionally trying to create late fees by misapplying mortgage payments (e.g. not applying it to principal+interest), not posting payments right away, or by rejecting payments. I believe that late fees are often erroneously charged due to mistakes by the servicer. It’s not really in the servicer’s interest to try to generate late fees. While servicers keep all of the late fees, most servicing contracts only allow the servicer to keep late fees only after the mortgage becomes current. Erroneously charging late fees imposes a cost on the mortgage servicer as it has to spend time on employees to fix the problems and to provide customer service.
From a legal standpoint, the servicer has no legal right to late fees that it is not entitled to under the mortgage contract.
If a borrower gets a loan modification, the borrower has essentially received “free” money. Loan modifications are bad for mortgage investors. However, for the mortgage investor loan mods may be better than a lengthy and expensive foreclosure process. While loan modifications lower the UPB (unpaid principal balance) and therefore servicing fees, the servicers’ incentives do not necessarily align with the investors’ interests. A loan modification may allow the servicer to quickly recover their advances, unpaid servicing fees and late fees. If the servicer were to liberally give away loan modifications, their expenses would come down because they would spend less money going after delinquent borrowers and be able to recover their advances faster. To ensure that the servicer does not give away too many modifications, the servicing contract establishes what the servicer can and cannot do when it comes to loan modifications.
There are a few private-label/non-agency securitizations that do not allow any loan modifications. To solve that particular problem, the US government implemented the HAMP program to refinance such loans. Because of HAMP and other programs, servicers are able to offer some type of loan modification to struggling borrowers. (*Loan modifications are rarely available to mortgages that are current. So, the right strategy is for borrowers to be irresponsible and to stop paying their mortgage. This will allow them to qualify for a loan modification. Struggling borrowers who have lost their job may not want to borrow money from friends, family, or credit cards to stay current on their mortgage.)
Not all loan modifications make sense for the servicer and/or mortgage investors. There are legitimate reasons for the servicer to reject a proposed loan modification. However, servicers may turn down a loan modification simply because their staff are overworked and did not have time to adequately go over a loan modification application. If there are errors on an application, the servicer and the borrower would have to go back and forth to fix the problems. A servicer’s staff may be too overworked to do this.
Alternatively, a servicer may simply decide to foreclose on a mortgage rather than spending time and effort on a loan modification that may fail. With a foreclosure, the timeline is fairly well known. While foreclosures are expensive for the servicer, the servicer will ultimately get their advances back once the foreclosure is completed and the REO sold. Had the servicer pursued a modification instead, a failed application may lengthen the foreclosure timeline because the servicer delayed foreclosure to try to negotiate a loan modification. Current regulations prevent servicers from “dual tracking” a loan modification and foreclosure at the same time.
Servicers normally collect escrow payments. They store these payments in an escrow account to pay for the taxes and insurance on a home. Escrow is complicated if the insurance or tax payments on a home change. See:
If servicing rights are transferred, the new servicer may decide to collect higher escrow payments up to the legal maximum to keep a higher reserve in the escrow account. This will ultimately lower the servicer’s costs if the borrower ultimately defaults on the mortgage. Instead of advancing money to pay taxes and insurance on the property, the servicer can pay those expenses out of the escrow account. In some cases the servicer can keep all of the interest generated by the escrow account. Servicers may erroneously calculate the wrong escrow payment amount.
If the borrower pays for taxes and/or insurance, complications can arise. Insurance is the most complicated. The mortgage contract requires the borrower to maintain a specific level and/or types of insurance. The borrower may have insurance that does not cover enough (e.g. floods). In such a situation, the servicer may require the borrower to change their insurance policy. Disputes can arise if the servicer makes a mistake in determining whether or not the consumer’s current insurance policy is good enough.
In some cases, a servicer may fail to pay the borrower’s insurance on time. This would clearly be the servicer’s mistake.
Force placed insurance (“lender placed insurance”)
Mortgage contracts generally require the borrower to maintain proper insurance. If the borrower allows the policy to lapse, the servicer may purchase insurance on behalf of the borrower. If the borrower defaults anyways, the mortgage investors will eat the cost of the force-placed insurance. Otherwise, the borrower covers the cost of the force-placed insurance. There are some laws that protect the consumer in this area. If the borrower demonstrates sufficient coverage, the servicer has to refund the cost of overlapping coverage.
Servicers can make mistakes by force-placing insurance onto customers who already have sufficient insurance. Such mistakes are more likely to happen if servicing has been transferred to a new servicer.
Another issue with force-placed insurance is that most mortgage servicers take kickbacks/commissions on the insurance. This has led to numerous lawsuits, expensive settlements, and regulatory scrutiny. See my previous posts on force-placed insurance (here and here). Some mortgage investors have rules against kickbacks on force-placed insurance. Fannie Mae implemented rules that went into effect on June 1, 2014 (PDF). If you skim through the Walter/WAC 10-Q, you will see that profits from “sales commissions” have dropped likely due to the Fannie Mae rules:
Due to recent regulatory developments surrounding lender-placed insurance policies that became effective in June 2014, our sales commissions related to lender-placed insurance policies began to decrease in June 2014. We are actively looking at alternatives to maximize the value of our insurance business. However, there is no assurance that our efforts will be successful in preserving for our shareholders all or any part of the value of our lender-placed insurance business.
As far as the CFPB goes, it seems that the CFPB does implicitly allow for small kickbacks on force-placed insurance:
Any force-placed insurance policy must be purchased for a commercially reasonable price.
Cross Country Home Services
Cross Country Home Services (CCHS) is a little nefarious. They mail consumers a $2.50 cheque. If the consumer cashes that cheque, they are enrolled into CCHS’ warranty program and are billed monthly (see “Mortgage Rebates Were a ‘Trojan Horse,’ Class Says“). Their 2013 fact sheet lists some of their “Major Business Clients” in mortgage services: CitiMortgage, Ocwen Loan Servicing, Nationwide Advantage, Regions Mortgage, GreenTree Loan Servicing, US Bank Mortgage.
Monthly payments go up
Many consumers complain about their monthly payments going up for mysterious reasons. This may be due to any of the following:
- The servicer made a mistake.
- The servicer increased escrow payments. This may be legitimate (e.g. taxes increased) or unreasonable (the servicer is asking for more escrow than is legally allowed in that particular state).
- The servicer force-placed insurance, possibly erroneously.
- The borrower does not understand that they are no longer paying a ‘teaser’ rate on their mortgage. Many borrowers actually do not understand their mortgages.
- Cross Country Home Services.
If the customer defaults, the mortgage servicer may purchase default-related services (or other services) on behalf of the mortgage investors. Some people allege that the servicer may be paying above-market rates on default-related servicers for kickbacks or other considerations.
Ocwen’s CFPB consent order requires that all fees be reasonable in amount and seems to forbid kickbacks:
All default, foreclosure and bankruptcy-related service fees, including third-party fees, collected from the borrower by Servicer shall be bona fide, reasonable in amount, and disclosed in detail to the borrower as provided in paragraphs I.B.10 and VI.B.1.
Servicer shall be prohibited from collecting any unearned fee, or giving or accepting referral fees in relation to third-party default or foreclosure-related services
Metric #4 in the consent order relates to “Accuracy and Timeliness of Payment Application and Appropriateness of Fees”. Ocwen and Wells Fargo are currently the only servicers in compliance with all of their CFPB metrics (see https://www.jasmithmonitoring.com/omso/reports/compliance-in-progress/).
Suppose that a borrower serviced by Ocwen proposes a short sale. Ocwen has some obligation to protect the mortgage investors against fraud because there may be incentives for the borrower and the borrower’s real estate agent to sell the house too cheaply. Real estate agents generally want to make a transaction as quickly as possible rather than to get the best price for the client. To defend against this, Ocwen will list the home on Hubzu, an auction marketplace owned by Altisource. If Hubzu generates a higher bid, then Ocwen will have gotten a better price on the home for the mortgage investors. Hubzu will get a small commission for the sale while the original real estate agent will also get a commission (which would be reduced versus no sale on Hubzu).
Bill Erbey owns large stakes in both companies so he stands to benefit from Ocwen steering business towards Altisource.
Foreclosures and robosigning
Servicers are incentivized to complete foreclosures as quickly as possible. When a loan becomes delinquent, the servicer has to advance the unpaid principal and interest payments to investors. It also has to advance the costs associated with the default, foreclosure process, and selling the resulting REO. The servicer has to eat the cost of financing these advances. The faster the servicer receives its advances back, the better. This may be at odds with what the borrower wants.
Conversely, borrowers may want more time before a foreclosure is completely. They may need time to try to close a short sale or to obtain some type of loan modification. They may also want more time simply so that they can continue to live in the home rent-free.
The ‘robosigning’ controversy occurred because the big banks were very sloppy in foreclosing on borrowers. Employees did not spend adequate time making sure that they were properly foreclosing on borrowers. This was driven by their incentive to foreclose as quickly as possible and to do it in a low-cost manner. Sloppy work can also be attributed to not having enough staff to handle the huge wave of foreclosures.
“Backdating” of letters
Benjamin Lawsky of the NY DFS has attacked Ocwen for “backdating” letters to borrowers. I don’t think Ocwen intentionally backdated letters because it makes no sense to do so; they strike me as unintentional errors. Ocwen naturally has an incentive to modify loans. It also has an incentive to reject loan modifications that do not make sense. If Ocwen wishes to reject a loan modification, there is no need for Ocwen to lie about it.
The big picture
The simplest way of looking at these issues is to look at the servicers’ compliance with the CFPB. As mentioned previously, take a look at their compliance with metrics set out by the CFPB: https://www.jasmithmonitoring.com/omso/reports/compliance-in-progress/.
*Disclosure: Long OCN and ASPS.