What is Loan Servicing?
Loan Servicing is a process in which entities known as loan servicers, perform various administrative tasks related to loan repayments such as a collection of interest and principal, payment of insurance and taxes, posting statements on regular basis to the loan borrower on behalf of the lender or loan originator (banks or other financial institutions) in consideration for a predetermined fee (generally denoted as a percentage of the contractual payment).
Why Did Loan Servicing Comes in Picture?
Initially, the loan servicing part used to be handled by the organization, which has provided the loan in the first place. But, over the years, it has changed since the advent of securitization. In the past two decades, entities have started to get into the niche activities or their area of specializations, such as client acquisition rather than using its resources to manage administrative works, for clocking the earning at a higher pace.
Nowadays, lending entities after providing the initial funding, sell these assets (loan books) to other companies or third-parties, known as Loan Processors. After partaking with the mortgage-backed loans or the other ones like student loans, personal loans, etc., the originator transfers all the administrative tasks such including handling the defaults.
Duties of Loan Servicers
A loan receiver takes care of the administrative part of the financial organization when it comes to the collection of principal and interest. These are not the sole responsibilities of the processing agencies, but it needs to carry out other ancillary activities too.
Following activities are being carried out by a loan servicer:
- Collection of interest and principal from the borrowers at the regular intervals.
- Transfer the remaining amount to the primary/secondary lender after deducting its charges from the received amount.
- Maintenance of required documents such as loan schedules, balance payments, etc.
- Conducting communication with both parties on an intermittent basis.
- Taking care of taxes and insurances, if applicable.
- Managing impound and escrow accounts.
- Keeping a tab on the customer if it went delinquent.
How Does Loan Servicing Companies Get Paid?
- Entities involved in this business receives the remuneration in the form of retention fees. It is a small percentage of the repayment received from the customer. The terms and conditions are pre-decided between the agency and the loan originators, and that is widely known as servicing fees or servicing strip.
- Typically it falls in the range of 0.25% to 0.50% of the contracted payments. Apart from that, the loan servicers would also be entitled to the late fees and other related charges as applicable, on case to case basis.
- For example: let’s say, the total outstanding balance of the borrower is $600,000, and the tenure for the repayment is for 12 months. The applicable service fee is 0.50% of the repayment amount. So, the entity would receive $50,000 a month. This transaction would provide the loan servicing company earnings of $250 for each payment. The loan servicer would take its share and tender the remaining balance to the loan originator or primary lender.
Advantages of Loan Servicing
Some of the advantages of loan servicing are as follows:
- Loan servicing has become a favorite choice of the loan initiators because it leaves them enough room for focusing on the newer client acquisition, which turns out to be more profitable.
- Also, as one loan servicer would be catering to multiple banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. , it develops a core competency in this arena. It could get the job done at a lesser price and time. It reduces the overhead cost of the companyOverhead Cost Of The CompanyOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc. to a great extent.
- It is a win-win situation for all the parties viz., lender, and borrower because the borrower gets a faster response and service. On the other hand, the primary lender could use its resources in more productive activities such as adding new clients to its organization.
- The loan processing agencies do a lot of additional work too. Apart from handling the core work of managing payments and issuing statements, it also does other jobs such as managing the delinquent clients, etc.
- When a client defaults, it is very challenging to handle the situation, if the bank itself is involved as it requires a different set of requirements. Still, as the processors are in this space, they bring with them the expertise in this area. They follow up for all the repayment default and manages it well.
- The loan processing companies do have advanced and sophisticated systems in place as they need to handle a vast amount of data. These facilities come at a steep price, but as the workload is high at the company, it gets managed.
- This advanced mechanism could be a costly affair if being installed by the primary lender because the cost per case would be higher due to lower clients in comparison to processing agencies.
- There is a cutthroat competition in the lending industry. So, the companies don’t leave any opportunity to woo their customers and take care of customer satisfaction as their priority. Once, all the administrative work has been transferred to the external agencies, and there is plenty of room to attend the needs of the customers.
Loan Servicers has turned out to be a boon for the banking industry as it takes away a major chunk of administrative work from the loan originator or the primary lender, and execute it with an ease which has been developed over the years by servicing multitude of clients and developing their core competencies in this area. It is beneficial to all the parties because when we give someone their best efforts at their core competencies or specialization, the best results tend to happen.
This has been a guide to what is loan servicing and its definition. Here we discuss how does loan servicing companies get paid along with its duties and advantages. You can more about finance from the following articles –