'Mortgage Servicing' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Mortgage servicing refers to the organization that handles the administration of a given mortgage loan. When many individuals obtain a mortgage, they mistakenly believe that their lender is going to keep and service this loan until they repay it in full or alternatively sell the house. This is not true much of the time, if not most of the time. In the competitive mortgage market of today, the loans a bank makes and its rights to service them it will commonly sell or buy. This simply means that in many instances, individuals send their payments in to a different company than the one which actually holds their loan.
It is useful to understand the definition of a mortgage servicer. These entities carry the responsibility of managing the daily needs for a given account on a mortgage loan. This includes a number of different services which they perform for the loan. The mortgage servicing model includes receiving and applying the every-month loan installment payments. Servicers also manage the escrow account for any mortgage that possesses one. It is this servicer who homeowners will call or email if they have questions regarding the mortgage itself or any particulars of the loan account.
This administration involved in mortgage servicing revolves around administering the loan from the time the loan proceeds are paid out all the way through the repayment of the loan in full. Besides the obvious tasks that a servicer will perform on a mortgage account, there are several other critically important ones. The servicer must collect and make payments on both insurance and taxes for the borrower. They have to deliver the received funds to the holder of the mortgage. Finally, they have the unpleasant but necessary task of dealing with any delinquencies on the mortgage accounts.
The mortgage servicers receive their compensation for these services in a particular way. They get to keep a fairly small percentage of every loan installment payment. This is called the servicing strip or servicing fee. It typically amounts to between .25% and .5% of the amount of the periodic interest payment.
Looking at an example of how this compensation works out in practice is helpful. When a remaining balance on a given mortgage proves to be $200,000 and there is a servicing fee amounting to .50%, the mortgage servicer will keep .005 divided by 12 months times $200,000 to arrive at a servicing amount of $80. They will retain this $80 from the coming periodic payment and then turn in the rest of the payment amount to the holder of the mortgage.
These mortgage servicing rights can be bought and sold on the secondary market. This happens in a similar fashion to the MBS mortgage backed securities trading. In fact, the mortgage loan servicing value works out to be much like the MBS IO strips value. This is referred to as MSR Mortgage Servicing Rights. Such servicing rights are actually contracted. They provide the rights to service the original mortgage. The initial lender will often sell these off to another firm that specializes in servicing mortgages. The contract will then specify what percentage amount the servicer will keep from each payment.
Though it is hard to believe, the United States national banking laws permit these lending institutions to sell their mortgages and/or servicing rights to any other institution they wish without having to first obtain the consent of the borrower or even to alert them of the change. This is because the interest rate, payment amount, kind of loan, and other terms will stay the same regardless of who services the mortgage. The only difference is that the company and address where the borrower sends the payments will be different.
Lenders might choose to sell these mortgage servicing rights in order to make available additional funds to more borrowers who wish to obtain mortgages. This is necessary as the majority of loans on homes take from 15 to 30 years (or even longer) to repay. Banks would requires billions of dollars in funds to loan out in order to meet the mortgage market demand if they had to keep all of their loans on the books ad infinitum. By selling the loans and/or servicing rights, they are able to help more individuals into homes.