Mortgage Servicing Fees and Servicer Behavior: A Close Examination of the Unexpected Heterogeneity in Servicing Fees

Abstract

Even though mortgage servicing plays an important role in housing finance, directly affecting millions of homeowners and mortgage-backed security investors, its economics is not well understood, hence making policy formulation and implementation challenging. To fill this gap, we examine the determinants of servicing fees in the non-agency mortgage market and explore how the current compensation structure affects servicer behavior during default remediation. We show that servicer compensation reflects expected mortgage termination risks and depends on whether servicing is outsourced. Furthermore, servicing fees decrease with deal allocation, which suggests economies of scale in servicing, and increase with the intensity of default in servicers' mortgage portfolios. Finally, it appears that issuers' drive to maximize deal returns by auctioning mortgage servicing rights leads to servicing fees determining mortgage modifications and foreclosures, possibly to the detriment of security investors. This is the first study addressing this potentially serious incentive problem in mortgage servicing. The economics of servicing will continue to produce low levels of mortgage renegotiation, despite the Dodd-Frank requirements on servicers.