WASHINGTON — A top Federal Reserve Board official on Tuesday pressed for changes in mortgage servicing agreements to encourage more workouts of troubled loans.
"The standard servicing contract provides disincentives for servicers to act in the best interests of investors and borrowers," Sarah Bloom Raskin, a Fed governor, said in prepared remarks to the Maryland State Bar Association. "This misalignment of incentives has more profound consequences when defaults are high."
Raskin said the current standards for servicing loans have slowed a real estate recovery. The compensation structure for servicers is not suited to the high volume of nonperforming mortgages, servicers lack the incentives to prevent foreclosures and their internal controls need improvement to handle the workload, she said.
"The imperative for servicers to fix their systems, review past decisions, and put in place the internal systems and controls that they should have had all along has impeded the repair of the overall housing market," said Raskin, a former Maryland banking commissioner.
She called for serious changes in how mortgage servicing firms are compensated.
"It is imperative to reconsider the compensation structure so that servicers have adequate incentives to perform payment processing efficiently on performing mortgages, and to perform effective loss mitigation on delinquent loans," she said.
Servicers typically receive a flat fee per loan they service, usually 0.25% to 0.5% of an unpaid loan's balance each year, depending on the type of loan. Raskin said while that is more than enough for servicing performing loans, it is much less than what is needed to service a delinquent loan. She added that the compensation structure does not motivate servicers to try to prevent borrower defaults.
"Servicer compensation is not generally tied to the performance of the loan, and in most cases a servicer receives no extra payment for preventing a default," Raskin said. "Further, loan modifications are labor intensive, and this extra labor cost is not reimbursed under the contract."
Servicing agreements, she said, need to be changed or renegotiated in order to facilitate more workouts and offer more clarity on when loan modifications and other mitigation strategies should be pursued. She said currently there is not enough language in contracts to encourage modifications, especially for securitized mortgages, and even when there is some guidance servicers are worried about the potential for litigation if they act too aggressively.
"When mortgage delinquencies are high, mortgage servicing is not profitable, and servicers may feel extra pressure to cut costs as much as possible," said Raskin. "Servicers may not be properly motivated to perform loan modifications even when such modifications are in the best interest of borrowers and investors."
She said investors in mortgage-related assets also need tools to monitor servicer performance, such as customer satisfaction ratings.
