What Is Loan Servicing?

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Loan servicing refers to the administrative tasks involved in managing a loan from the moment the loan funds are disbursed to the borrower until the loan is fully paid off. This includes sending monthly payment statements, collecting monthly payments (which cover principal, interest, taxes, and insurance), maintaining accurate records of payments and balances, managing escrow funds, remitting payments to the loan owner or note holder, and handling any delinquencies or late payments.

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For the borrower, loan servicing directly affects their experience throughout the life of the loan. The servicer is the point of contact for making timely payments, receiving statements and account information, and managing repayment plans. Proper servicing ensures that payments are applied correctly, taxes and insurance are paid on time, and any issues like missed payments are addressed promptly. Poor servicing can lead to confusion, misapplied payments, or even wrongful penalties, which can negatively impact the borrower's credit and financial standing.

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In summary, loan servicing is essential for maintaining the borrower's loan account accurately and smoothly, helping them stay on track with their repayment obligations and avoid complications.

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Key Takeaways

• Loan servicing is a function carried out by the bank or financial institution that issued the loan, a third-party vendor, or a company that specializes in loan servicing.
• Loan servicing functions include collecting monthly payments, paying taxes, and other aspects of the loan that occur from the time the proceeds are dispersed until the loan is paid off.
• Securitization of loans made loan servicing less profitable for banks.
• Loan servicing is now an industry in and of itself and companies are compensated by receiving a small percentage of loan payments.

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How Loan Servicing Works

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Loan servicing can be carried out by the bank or financial institution that issued the mortgage loans, a non-bank entity specializing in loan servicing, or a third-party vendor for the lending institution. Loan servicing involves collecting payments, including principal, interest, and escrow payments, from the borrower. It also encompasses managing repayment plans such as income based repayment (IBR) or income driven repayment (IDR) plans, maintaining accurate account information, and ensuring timely payments to maintain creditworthiness with lenders and credit-rating agencies.

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Traditionally, loan servicing was a core function held within banks, as they originated and serviced the loans. However, with the widespread securitization of loans, especially mortgage servicing rights being sold off, servicing has become a distinct business. Once loans were repackaged into mortgage-backed securities and sold, servicing the loans became a less profitable line of business for banks compared to originating new loans.

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Consequently, the loan servicing process was separated from loan origination and opened up to specialized loan servicers and financial institutions. Given the complexities of collecting payments, managing escrowed funds, paying taxes and insurance, and the evolving needs of borrowers, the loan servicing industry now heavily relies on advanced technology and software to efficiently handle these tasks.

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Loan Servicing Example

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Imagine a borrower takes out a mortgage loan to buy a home. Each month, the borrower makes a payment that includes principal (the amount borrowed), interest (the cost of borrowing), and escrow payments for property taxes and homeowners insurance. The loan servicer collects this monthly payment, records it accurately, and ensures the principal and interest portions are applied to reduce the loan balance. The servicer also manages the escrow account by using the escrow funds to pay the property taxes and insurance premiums when they are due. Additionally, the servicer sends monthly statements to the borrower, answers any questions, and follows up if a payment is late or missed. The servicer then remits the principal and interest payments to the loan owner or investors who hold the mortgage-backed securities. This comprehensive management of the loan throughout its life is what loan servicing entails.

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What Happens to Your Loan?

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Orion encourages brokers to help your clients all the way from looking for a home to servicing their loan every month after it funds. When their loan closes, we think it is important for you to know what happens next, so it is valuable for Orion's brokers, and your clients, to understand how mortgage-backed securities (MBS)are formed.

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When Orion provides a borrower with a home loan through a trained broker, and the borrower agrees to pay the money back by signing a note, Orion has two options. We can either collect the money that the borrower is paying every month, or sell the loan to Fannie Mae, Freddie Mac, or a large aggregator, thereby providing Orion with more cash to make more loans, which is what we do best.

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Most independent mortgage banks chose the latter option (carried out by the Capital Markets Department).Meanwhile, the aggregator is purchasing thousands of other loans from different lenders that have similar interest rates and terms in order to create a large pool of loans, called a mortgage-backed security. The aggregator then sells parts of the pool to investors, so the aggregator has new funds to purchase more mortgages, create more MBSs and sell parts of them off to investors.

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This mechanism was created in the 1970s, and has continued to work very well. The investors in these securities, which range from individuals to huge insurance companies and pension funds, know the types of loans that make up the MBS and are comfortable with the risk. In the early 2000s, however, to increase profits lenders lowered their standards and granted loans to subprime borrowers who had low credit ratings and a high risk of defaulting on their loan. Unfortunately for many lenders this didn't matter because the lender passed the risk of default on to the MBS investors.

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The Bottom Line

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Lenders such as Orion and investors are once again focused on originating quality loans with solid documentation and appraisals, and once again investors are fully aware of the collateral making up the MBS. This not only helps the flow of funds, but also helps to keep rates low for your borrowers, and that is important! And if you have questions, Orion's Capital Markets Department is happy to answer them.

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