By Dennis Doss
Many private money brokers outsource the servicing of their loans to avoid the stiff rules of the Department of Real Estate as to the handling of trust accounts. I don’t blame them. The number one cause for discipline against mortgage brokers is trust fund mishandling. The DRE is merciless and they have the right to be. After all, a real estate broker can handle millions of dollars in collections without any net worth or bonding. Nevertheless, mortgage brokers have the right to claim the servicing rights on their loans because they originated them. The servicing rights are an ASSET worth a lot of money. Sadly, many brokers “squander” their servicing rights to a third party servicer for nothing–leaving serious money on the table. I will explain how serious below with an example.
There is a simple way to have your cake and eat it too. A savvy mortgage broker will sign his or her investor up to a good loan servicing agreement and then hire, at a rate far below what the investor is paying the broker, a professional third party subservicer to handle the money and the reporting. That way they build an annuity consisting of the “spread” between the note rate and the pass-thru rate to the investor. They also pick up a portion of late charges, default interest, some of the prepayment penalty and the possibility of other income such as a portion of the gain on the sale of any real estate taken back in foreclosure. Because the broker is the technical servicer, the broker controls who is doing the subservicing. The broker can change subservicers at will if the broker is unhappy with the subservicer or he or she can get the work done more cheaply elsewhere. The subservicer has all of the reporting obligations to the DRE and income tax authorities.
We are talking serious money here! Let’s assume you service just $10 million in loans at a servicing rate of 1% (many broker charge more). Let’s assume your subservicer charges you half of that amount (some charge less). In one year, forgetting the income you will have made from default interest, late charges, prepayment penalties, gain on sale, etc., you will have earned $4,166 per month or $50,000 in one year. All you had to do was sign your investors up to 2-3 page servicing agreement and sign one master subservicing agreement with a subservicer. Your profits on this arrangement will buy you a new car every year! In 20 years you will have banked $1 million you don’t have now.
So, it may be time to dust off that loan servicing agreement lurking somewhere on your computer and see if it is up to par. Doss Law, LLP offers modern loan sale and servicing agreements. But if you want to update your own, use the checklist below as a start.
Recommended Deal Points in Your Servicing Agreement with your Investor
- Servicer is entitled to life-of-loan compensation if investor terminates servicing. The contract is valueless if the investor can fire you without paying you what you would have earned
- Servicer is indemnified by the investor in case of suit involving the loan or by a buyer of real estate following foreclosure
- Servicer has the right to repurchase the loan at par
- Servicer has the right to be paid its fees and reimbursed for its advances out of first monies collected and has a lien to protect that right
- Servicer’s compensation continues to be due and payable even if the loan is in default or becomes real estate owned
- Servicer has the right to charge a reasonable fee for extraordinary services
- Servicer is entitled to a percentage of any profits on the resale of real estate taken back in foreclosure
- Advances by the servicer bear are subject to an advance fee and bear interest
- Servicer is entitled to all or a portion of late charges and default interest
- Servicer has the right to amend the agreement after giving notice
- Servicer is entitled to a fee for assignment of the loans to other parties
- Servicer has the right to transfer servicing or hire a subservicer
- Claims are subject to mandatory arbitration and award of attorney fees
Required DRE Verbiage In Loan Servicing Agreements
- Notice to the investors within 15 days of the recording of a notice of default, notice of trustee’s sale, receipt of an amount in excess of five or more monthly payments, payoff request, request for reconveyance, 30 days or greater delinquency (Business and Professions Code 10233)
- Requirement that payments be deposited into a broker trust account maintained under required DRE rules (10238)
- Requirement that monies collected not be comingled with the assets of the servicing agent or used for any other transaction (10238)
- That payments collected shall be remitted to the investors within 25 days of receipt (10238)
- Notice to the investor if someone other than the borrower makes a payment (10238)
- Special language confirming that the broker will comply with the threshold reporting requirements of the DRE if the loan is a multi-lender loan (10233)
- Prompt notice to the investors of default under any senior encumbrance (10238)
- Confirmation the servicing agent will forward to the investors a copy of any notice of trustee’s sale filed by the servicing agent (10238)
This article is intended as educational material not legal advice. Consult a knowledgeable lawyer before implementing any of the ideas in this publication.