What Are Mortgage Servicing Rights (MSR)?

What Are Mortgage Servicing Rights (MSR)?

Let me explain mortgage servicing rights, or MSR, directly to you. These are contractual agreements where the original mortgage lender sells the right to service an existing mortgage to another party that specializes in handling the various functions involved with servicing mortgages.

Key Takeaways

You should know that mortgage servicing rights are sold by the mortgage originator to another financial institution, which then takes over the administration of the mortgage, including tasks such as collecting payments and forwarding them to the originator. The original lender pays the servicer a fee for performing this work. For the mortgagor, nothing changes except the address to which payments are sent.

How Mortgage Servicing Rights (MSRs) Work

Mortgages come with ongoing administrative duties that need to be processed for the entire length of the loan. Common rights included in MSRs are the right to collect monthly mortgage payments, set aside taxes and insurance premiums in escrow, and forward the interest and principal portions to the mortgage lender. In return, the servicer gets compensated with a specific fee, as outlined in the original contract.

The mortgage payment amount, interest rate, type of loan, and other factors stay the same. As far as you're concerned as the borrower, only the address for sending payments changes, and you should contact the servicer, not your original mortgage lender, with any questions about your loan. Your servicer can change at any time, but you should receive notice from your original lender at least 15 days before it happens, and your new servicer should notify you within 15 days of assuming rights as well.

Important Note

Federal banking laws allow financial institutions to sell mortgages or transfer servicing rights to other institutions without needing consumer consent.

Example of Selling an MSR

Consider this example: Sarah takes out a $500,000 mortgage from Lender A. She sends the lender a monthly payment of principal and interest. Three years later, Lender A transfers its MSR on Sarah’s mortgage to Company B. Under the contract terms, Company B is paid a fee by Lender A for processing all of Sarah’s remaining mortgage payments. The mortgage lender can then spend more time and money providing new mortgages, while the company that assumes the MSR forwards the mortgage payments to the lender. Sarah now sends her monthly payment to Company B instead of Lender A.

Special Considerations

A lender will often sell MSRs to free up lines of credit so it can lend money to additional borrowers. The majority of mortgages last 15 to 30 years, and the bank needs billions of dollars to lend money to other consumers requesting mortgages during this time. Because the term is so long, you need to do thorough research among the best mortgage lenders.

In a roundabout way, selling MSRs means that more people can become homeowners because the sale of these rights produces revenue. Lenders also make money by charging fees for originating mortgages and earning monthly interest from payments. Mortgages are simply additional assets that bring in more revenue for banks.

History of MSRs

The market for MSRs tends to be strong during periods of economic growth, due to higher quality mortgage originations and fewer defaults. Hedge funds, banks, and real estate investment trusts (REITs) find these assets attractive because MSRs can yield high amounts of interest. For example, SunTrust purchased $8 billion in MSRs in the first quarter of 2016 as a means of earning a solid return on investment (ROI), and within months, its MSR portfolio contained $121.3 billion in unpaid principal balances of loans that the bank was servicing for lenders.

National Mortgage News reported in June 2019 that MSRs 'have been one of the best-performing fixed-income asset classes over the past five years.' However, it also reported that 'since October 2018, as medium- and long-term interest rates have fallen, projected and actual mortgage prepayment assumptions have accelerated, causing the expected average life of MSRs to shorten considerably.' As a result, 'MSR values from April to May were down consistently (by a half) multiple.' That said, reports National Mortgage News, 'the demand from MSR buyers is still very strong, and there is general consensus around MSR values.'

What Is Mortgage Excess Servicing?

Mortgage excess servicing is a fee based on the excess cash flow after a basket of loans is pooled together and securitized. This is paid out to mortgage servicers as a fee to maintain a mortgage-backed security.

Why Do Banks Sell Mortgage Servicing Rights?

Banks sell mortgage servicing rights to free up lines of credit. This allows them to lend more money, ultimately helping more people finance properties.

How Do You Value Mortgage Servicing Rights?

According to the Federal Housing Financing Agency (FHFA), the value of a mortgage servicing right is determined by the discounted present value of future cash flows, adjusted for the expected amount of prepayments.

The Bottom Line

Mortgage servicing rights, or MSRs, allow a company to purchase the cash flow from a mortgage, even if that person is not the original mortgage lender. Banks and lenders sell MSRs to free up capital, thereby allowing them to originate more loans. Nothing changes for you as the borrower, except the address where you direct your payments.