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November 24, 2000
"I am a mortgage
broker who arranged a loan for a client who made a monthly payment on the 16th
of the month - one day after the grace period. Without notice, the lender
imposed a late charge on that payment, and then proceeded to collect that charge
by deducting it from the following month�s payment. That payment was made on
time but recorded as late because of the deduction of the late charge from the
previous month, which generated still another late charge. Seven consecutive
payments were made on time but recorded as late because of the deduction of late
charges on the prior payments. What can I do for this borrower?"
You have
already done something by championing his cause well past the point where you
had any financial interest in his case. Not all mortgage brokers would bother.
Start with a
lecture about the importance of disciplined payments habits. Most mortgage
contracts offer borrowers a 15-day grace period, with a late charge of 5% on
payments received after the 16th.
On a 8% 30-year
mortgage, a borrower who makes every payment on the 16th day will pay
a true rate of about 7.97% because of the 15 days of grace every month. The
borrower who makes every payment on the 17th with a 5% penalty will
pay about 8.49%. That�s a heavy price for being careless.
But your
client�s sloppiness is no excuse for the vicious trick played on him. Not only
does it extract more late fees but it also blackens your client�s credit
record.
The game is
motivated by the economics of loan servicing. In recent years, servicing has
become an increasingly specialized activity. Many firms originate few or no
loans, but purchase servicing contracts as an investment. Even among firms that
both originate and service loans, servicing is viewed as a profit center that
must justify itself by earning a target rate of return.
The investment
in servicing is what a specialized servicer pays for it, or what an originating
firm that retains the servicing could have sold it for.
For example,
lets say a firm pays $1 million for the right to service a loan portfolio of
1,000 loans with total balances of $100 million. The portfolio has an estimated
average life of 7 years. The servicing fee on the $100 million is .25%, which
generates income of $250,000 a year. It only costs the firm $50 a year to
service each loan, or $50,000 in total. Net income is thus $200,000 a year for 7
years. The rate of return on investment is 9.20%.
Now add late
charges, which by industry practice are retained by the servicing agent. If a
late charge of 5% of the payment is collected from just 1% of the borrowers, the
rate of return on the investment in servicing jumps almost to 10%. If late
charges can be collected from 5% of the borrowers, the rate of return exceeds
12%.
The
servicer�s interest in late fees doesn�t justify playing obscene games with
borrowers. Check whether state law permits the servicer to collect the late
charge from the monthly payment. I doubt they would if it is illegal, because it
would expose them to costly class action suits.
Assuming the
servicer is acting within the law, advise your client to pay the late fees. Then
he can suggest to the lender that if the so-called late payments are taken off
his credit record, he won�t tell his story to the press.
Readers should
not conclude that the practice described above is widespread. I discussed this
with Terry Klein, CEO of First Nationwide Mortgage, one of the largest
mortgage-servicing firms in the country. His view is that the practice is much
less common than it used to be. His firm and most other large servicers
increasingly view mortgage borrowers as potential customers for other products,
such as refinancing and home equity lines. Irritating customers with unfair late
fees is not a good way to sell them other products.
Copyright Jack
Guttentag 2002
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