Loan servicing refers to the administration of the loan’s payments by the lender, or an agent selected by the lender.
In its most basic form, loan servicing involves receiving payments from loan borrowers for regularly scheduled payments. But it also involves collecting loan fees, such as late charges, prepayment penalties and default collections.
With home mortgage loans, servicing also includes collecting escrow funds to pay hazard insurance premiums and property tax assessments.
When a loan is first executed, the loan documents give the lender the right to service those loans – i.e. collect the payments due on the loan. If the lender sells the loan to another bank or loan provider, the servicing rights are also sold to the new owner of the loan. Many lenders, especially commercial loan providers, do prefer to service their own loans. They have individual employees or departments tasked with servicing the loans they provide to borrowers.
However, there has been an emergence of loan servicing companies that handle the servicing duties for the official lender – especially in the residential mortgage loan industry. These loan servicing companies or agencies collect the monthly payments from borrowers, deduct what should be deducted and then submit the collected funds to the. When third-party servicers are used, lenders will assign their servicing rights to the loan servicer and typically receive their loan revenues through the servicer.
When a third-party loan servicer is used, those servicers are either private or publicly held companies that perform the following tasks for the lender:
Servicing companies generate revenue (and profits) by receiving a percentage of the unpaid balance on the loans they service.
Special servicers deal with borrowers in or near default. If the default is not final, they may try to bring the borrower back to good standing. If the loan has officially defaulted, special servicers will usually initiate the collection process by attempting to collect the balance of the loan from the borrower.
For secured or collateralized loans, servicers may go further to obtain repayment of the loan balance that is currently outstanding. With car loans, for example, loan servicers may repossess the car and sell it at an auction. The proceeds are then used to pay for outstanding fees and penalties, before paying off the loan balance. Similarly, with home mortgage loans, special servers may also handle the foreclosure of the property’s mortgage, on behalf of the lender.
This refers to companies (either public or private) that manage loans. Primary services are often the originator of the loan (i.e. original loan provider), and they maintain direct contact with the borrower. If the borrower defaults, a special servicer may be called in to take over. The main role of a primary servicer includes:
Third-party loan servicers profit by receiving a small percentage of the loan repayments. This amount is referred to as the servicing fee and it is normally 0.25% – 0.5% of the loan amount being serviced.
For instance, if the outstanding balance on a loan is currently at $100,000 and the servicing fee is approximately 0.25%, then the servicer is entitled to receive 0.25% / 12 months * $100,000 which equals $20 for the current month.
That may not seem like a lot, but when multiplied by thousands of loans under service, loan servicing revenues can start adding up.
Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.