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Mortgage Servicing Problems for Prepayments

posted by Adam Levitin

With all the problems in the mortgage industry caused by defaults, it's easy to forget that the traditional bugbear of mortgage lenders isn't credit risk, but prepayment risk.  If a lender contracted for a 6% return and the loan is prepaid, there's a chance that the best return the lender can get now is say 4.5%. 

As it turns out, prepayments can cause just as many problems for servicers as defaults.  Recently, one of my relatives laid into me with this story about her problems getting her servicer to correctly credit her prepayments.  The servicer has been crediting them all to interest, not to principal, so the loan balance isn't getting paid down (and the servicer is making more money that way, at the expense of the investors).  What's worse, is that the servicer says it can't correct the problem because some of the prepayments were made before it acquired the servicing rights.  And, the servicer says that if it corrected the problem, it would result in the account being listed as 30-days late and credit reported because the servicer did not make an automatic withdrawal one month because it treated the prepayment as a regular (but partial) payment (even though the total prepayments should put the loan way ahead on its original amortization schedule). 

Put another way, the servicer is saying that they cannot produce an accurate payoff balanceand that if the homeowner demands one it will result in her being credit-reported incorrectly. 

This aggrevating situation illuminates what a mess the mortgage servicing world is in.  For all of the attention justly paid to mortgage servicing problems with defaulted homeowners and servicing fraud in the context of default, my relative's case makes me wonder whether the rot in the servicing industry extends all the way up the tree, to an inability to properly handle transferred servicing rights and an inability to properly handle prepayments. 

And here's the real problem: consumers trust financial institution creditors to be competent and fair.  They trust that balances are right, that APRs are properly applied, that amortization schedules are correct, etc.  Without that trust, the entire system of financial intermediation cannot work.  Financial institutions trade in trust.  Absent that trust, every consumer would have to subject every credit card bill, auto loan bill, mortgage bill, and student loan bill, etc. to a forensic accounting.  That would be astonishingly inefficient.  We shouldn't want consumers to have to be so careful.  It's one thing to expect consumers to look at their bills to make sure that there are no unauthorized line items.  It's another to expect them to run interest and amortization calculations.

For the most part the system works, as it's all highly automated.  But when it doesn't, the power imbalance between the financial institution and the consumer puts the consumer at a serious disadvantage.  We really need a better system for resolving consumer disputes with financial institutions.  I'm not sure what it is, but maybe the trick is to avoid the disputes by making sure the FIs get things right. The least cost avoider of the errors is the financial institution, and we should really have stronger incentives for FIs to get it right. 

Comments

I don't think they are being honest. How could one's prepayments be applied to interest? One isn't liable for any interest before the time it is due since interest is a function of the amount of loan outstanding and the time it has been in force.

You don't owe any interest on the future it hasn't accrued yet.

They just stole the money.

Just a grain in huge grinding machine. You don't get noticed until you are boulder size.

I under stand the point though and it is way too common. Thing is that your right, most consumers can't grasp (or read because it's too small) the fine print. It’s like they are “bonuses” almost. There is no equality in consumers dealing with that huge machine. I think you right on track when you touched on the plain volume of it all. It’s like the system, as it is set up right now is capitalizing on the weak and the unfortunate bystander. Normally that’s counted for in a nice little percentile, all nice and safe. They even take out insurance on it. In good times, that’s just part of the package, a Darwinian survival of the fittest. In times like now, it runs over the same people it needs for its recovery and we know “insurances” only cover so much. In times of feast Servicers have very little incentive to fix things. After all they get to keep the fat anyway. It would be advantageous in todays economy, if Servicers developed a better “consumer friendly” interface. The easier the better.(well made point) If now is not the time then I don’t know when is?

I think now is different and that is to your relatives’ advantage. It sounds to be a “relatively” easy fix, but he can’t be a grain he has to be a boulder. It sucks it has to be that way.

Mortgage modification is a process whereby a home owner's mortgage is modified and both the lender and homeowner are bound by the new terms of the new mortgage.

The most common loan modifications are listed below:

lowering the mortgage interest rate
reducing the mortgage principal balance
fixing adjustable interest rates within the mortgage
increasing the loan term throughout the mortgage
forgiveness of payment defaults and fees
or any combination of the above

Check out this Public site at http://www.MortgageModificationInfo.org

I can think of a possible regulatory solution. Servicers these days, usually report to master servicers, who deal directly with the trustee. We can regulate with this institutional detail in mind. If the master servicer deals with the trustee, there is no reason why the consumer should have no say over the servicer. Have the consumer pick (or fire) the servicer, which in turn deals with the master servicer.

1.) Beachdude - what the Professor is addressing has absolutely ZERO to do with mortgage modification. Nice plug for the site, irrelevant as it may be.

2.) Professor, this is one of the many things that Mortgage Servicing Fraud victims have been screaming about for literally decades now. What you describe sound exactly like something out of the Fairbanks/SPS/Ocwen/Litton/EMC/Saxon/Wilshire ad naseum playbook. I swear there is a single business plan floating around the servicing conferences that they all model after. The fact that these things happen in dealing with so many different servicing entities simply cannot be coincidence or mistake.

http://www.getdshirtz.com/documents/RasmussenAffidavit.pdf
The fact that Fairbanks' VP of Information technology testified that they COULDN'T fix the problems in the system neither forgives them nor immunizes them from the consequences created by that failed system. The system that he refers to is, I believe, widely used in the industry and is not exclusive to Fairbanks/SPS. If such is the case, it would help explain why servicing issues are widespread.

I'd be willing to bet that I've already mentioned the servicer your relative is dealing with and if not, I'm sure I won't be surprised should you throw the name out there. If I remember the story correctly, I know of one Fairbanks victim who religiously sent in an **extra** $1000.00/month to have it applied directly to principle and every month that $1000.00 was placed into a suspense account rather than being applied to the loan. Why? My guess is that it has to do with the terms of the PSA and the fact that Fairbanks may have been able to keep any interest generated by holding that amount in suspense. Could easily be the same reason that your relative is having issues as well. Hold up one person for $10 - not such a big deal. Hold up 100,000 people for $10 and you're starting to talk about real money. Hold up 100,000 @ $10 each month, every month for a year and you've got a great profit stream going that, unless someone steps back and looks at the larger picture, no one would realize is happening. Who's going to bother to take action on behalf of a single borrower that was screwed out of $10? The only problem with this last statement is that I've been told that the Federal Trade Commission has between 90 and 100 boxes of "$10 complaints". And they STILL won't do anything to protect borrowers.

Good luck to your relative. Please feel free to have them get in touch with me if there is anything that I can do to shed light on anything.

If you think mortgage servicing is bad, try student loan servicing on for size.

Sounds like they need to contact scam.com or ripoffreport.com.

Adam, prepayment risk really isn't the bugaboo you make it out to be. It is factored in and has been part of the game for years. The term "runoff" is used to describe loans that go away.

You raise a salient point in that consumers should be able to trust financial institutions, but you fail to see that mortgage servicers are not financial institutions. They are unregulated quasi debt collectors who have NO oversight outside of the civil tort system. They can and will always operate in their own best interest regardless of what steps they have to take or not take.

They have deliberately fallen into the magic crack in the system that protects them even from criminal prosecution that would land ordinary perpetrators behind bars.

They get the benefit of the doubt in almost all situations. There has been only one civil penalty brought against one individual who was the architect of truly egregious and unlawful actions against consumers by his company.

There is no threat for executives in servicing abuse. They can basically do whatever they want as long as they are making enough money to keep their defense counsel engaged.

You are correct in that we need a better system to deal with disputes, but that is not going to happen.

Unless and until perpetrators of fraud against borrowers are actually prosecuted, the system will continue to take advantage of borrowers because it can. In many cases, if they can't supplement the bottom line with abuses that generate fees, they would be out of business.

And what executive is going to let concern for ethics and responsibility put his or her company onto the scrap heap just to "do the right thing?"

We don't have a financial crisis Adam. We have a moral and ethical crisis. No amount of legislation is going to fix that UNLESS the risk of CRIMINAL PROSECUTION (not just civil litigation) gets their attention and makes abusing consumers a slippery slope they aren't willing to let their employees take them out on.

Right now, business as usual isn't even risky. All you have to do to keep the bonuses coming in is have the right legal budget to keep civil litigation at bay.

Well said, Judge. The only debate I'll throw in is that I believe the individual in question settled out so there was no real civil conviction there - and the criminal investigation was dropped for some reason. And, let's face it, how much monetary damage did $400k really do to him? After all, he was still able to sell his roughly 11% stock off on a $143M sale, if I remember correctly, and fade away...

As a practical matter, always include a dated letter directing any additional payment(s) on your mortgage be applied to principal.

I haven't looked at this issue in a long time, but IIRC many notes allow additional payments to be directed to interest - even future interest - unless their is a specific direction that the monies be applied to principal.

It ain't right, but this type of problem isn't limited to mortgage loan situations.

The judge said; “We don't have a financial crisis Adam. We have a moral and ethical crisis. No amount of legislation is going to fix that UNLESS the risk of CRIMINAL PROSECUTION (not just civil litigation) gets their attention and makes abusing consumers a slippery slope they aren't willing to let their employees take them out on.”

Right on with the moral and ethical crisis. I agree! I would add that the aggregate generational corruption in the ‘rule of law’ has rendered it a total scam that needs to be purged. Interest is slavery pure and simple and should not be allowed. Bankers are parasitic cannibalistic scum bags that have been buying politicians and cannibalistic legislation since the American revolution. The electoral process is a further scam reflective of that scam rule of law that insures it all continues.

Academia, and its butt sucking crumbunist system of tenure, should be ashamed of itself for validating this cannibalistic crap system.

Its rip it up time!

I on the ball patriot

Similar to what Mike Dillon said, I actually ran into this in my mortgage as well. When making additional payments you had to indicate whether you wanted the additional funds to go to principal or interest (usually by checking a box). If neither was checked, the funds went to fund a future month's interest payments. I did it accidentally once, then since the next months interest was already paid, had the next month's payment go all to principal, which straightened the issue out. Always read everything. Unfortunately, I think the complexity of financial instruments available to the general populace has exceeded the general populace's financial acumen.

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