Mortgage Excess Servicing

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Mortgage Excess Servicing

What Is Mortgage Excess Servicing?

The proportion of the monthly cash flow of mortgage-backed securities (MBS) that is left over after the cash flow has been split into a coupon and principal payment for the MBS holder is used to calculate the mortgage surplus servicing charge.

Key Takeaways

  • Mortgage servicers get a charge called “mortgage excess servicing” for keeping up with mortgage-backed securities (MBS).
  • After monthly mortgage service costs have been subtracted, there is surplus servicing.
  • The bundling of mortgages into an MBS, where each loan may have a separate originator or servicer and each charging a different rate, may result in mortgage excess servicing.

How Mortgage Excess Servicing Works

When a borrower makes a mortgage payment, the mortgage servicer receives a portion of each payment as compensation for keeping track of payments, collecting and processing escrow contributions, and transferring principal and interest payments to the note holder. This is known as a servicing fee. The typical monthly servicing cost is between 0.25 and 0.5 percent of the outstanding mortgage amount. The mortgage excess servicing charge usually goes to the loan’s servicer and might be used as a guarantee fee by the MBS’s underwriter.

For instance, in a typical MBS transaction, if a mortgage’s interest rate is 8%, the MBS holder may earn 7.5%, the mortgage’s servicer could receive 0.25% in servicing fees, and the MBS underwriter might receive 0.15%. As extra servicing, the remaining 0.10% (8% – 7.5% – 0.25% – 0.15% = 0.10%) remains.

Prepayment and extension risk are present in the mortgage excess servicing for MBS. The estimated duration of the annuity is used to value extra servicing when it is priced. Since it is impossible to predict with certainty when a mortgage borrower would refinance or otherwise pay off his or her mortgage, this must be approximated. Because the length of the annuity of surplus servicing connected with a mortgage depends on changes in current interest rates compared to the mortgage’s interest rate, the value of excess servicing may fluctuate significantly as interest rates do.

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Where Mortgage ExcessServicing Comes From

The management of mortgages that are bundled by the originator and subsequently sold may lead to mortgage excess servicing. The buyer may engage into a servicing arrangement with the originator or a third party if they do not service the loan themselves. With regard to the whole pool of mortgages being serviced, the servicer will normally maintain the right to collect a portion of the interest payments made by the borrowers under such an agreement.

The amount of interest kept by the mortgage servicer is known as the mortgage servicing spread, and the servicer views it in part as a sort of fair remuneration for the work that was done. This is known as the excess servicing spread and would reflect a continued investment in the interest part of an underlying mortgage pool if a section of a mortgage servicing spread surpasses what may be considered adequate remuneration for services rendered.

The Internal Revenue Service (IRS) has decided in the past that ownership of certain mortgage excess servicing spreads would qualify as a real estate asset, and as a result, income from the excess servicing spreads would be regarded as interest on obligations secured by mortgages on real property. For taxation reasons, this decision was judged relevant to real estate investment trusts.

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