Predatory servicing deserves a cleanup
Recent years have seen a flurry of proposals and legislation directed toward predatory mortgage lending. The focus, however, has been almost...
Recent years have seen a flurry of proposals and legislation directed toward 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. Yet, in many respects, it is more vicious, and the adverse consequences are more far-ranging. The loan-origination market is a minefield for borrowers, but with a little homework, they can find a loan provider who will treat them fairly.
Borrowers have no choice in the firm servicing their loan, and they can't change the servicer, no matter how wretched its service. The only way they can extricate themselves from a predatory servicer is to refinance, which is costly and has no guarantees.
The financial incentives commonly used to provide good service work only selectively with loan servicing.
Servicers that originate loans have an incentive to provide good service to strong borrowers because they want them to come back.
But if borrowers have spotty payment records or the companies don't sell products, there is no real incentive to provide good service.
Predatory servicing could be reduced by legislation that restricted the sale of servicing contracts or gave borrowers the right to change servicers. These changes are drastic and would be difficult to enact.
The alternative is to identify predatory practices and make them illegal. Here is a partial list:
• Mandatory provision of complete and comprehensible monthly statement: The law should require servicers to provide easy-to-understand monthly statements showing every transaction during the month, including balance changes and their sources, payments, disbursements, rate adjustments and fees. Without this, predatory practices can go unnoticed by the borrower.
• No suspension of payments because of an escrow shortage: Servicers should be prohibited from placing scheduled payments of principal and interest in suspense accounts when only the escrow payment is short. This leads to unnecessary delinquencies and late payments and can lead down a slippery slope to collections and foreclosure.
• No profits from loans in collection: Servicers should be barred from marking up third-party fees — such as those for legal services and property inspections — on loans in collections. They also should be barred from receiving payments for business referrals or buying services from affiliated companies. Profiting from loans in collections is an incentive to move borrowers to that status needlessly.
• Mandatory reporting to credit bureaus: Servicers should be required to report payment histories on all accounts. They shouldn't cripple the ability of borrowers to refinance profitably by not reporting good payment records to credit bureaus.
• No conversions to simple interest: Servicers who buy loans should be barred from converting a mortgage to simple interest merely because the note does not prevent it. Simple-interest mortgages, which accrue interest daily, are more problematic for borrowers than standard monthly accrual mortgages.
• Mandatory disclosure of policy toward crediting extra payments: Servicers should disclose their procedures for crediting extra payments to the loan balance. Borrowers making extra principal payments have the right to this information so that they can make extra payments at the most advantageous time.
• Mandatory retention of complete servicing files: Servicers should be required to keep the complete file on every account until it is paid off. When servicing is transferred to a new company, that company should be required to obtain the complete file. That would stop companies from covering up abusive practices by selling the servicing to another firm while leaving evidence of the abuses behind.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Send questions or comments to firstname.lastname@example.org.