What it means
Servicing a mortgage means collecting monthly payments, passing money to investors, managing escrow for taxes and insurance, and dealing with borrowers who fall behind. The company that does this work earns a small annual fee based on the loan balance.
These servicing rights can be sold separately from the loans themselves. An MSPA sets out the terms of such a sale.
It names the loans, the price, the date of transfer and the duties of each side. It also includes promises about the loans, such as that they were made properly, and says what happens if those promises turn out to be false.
Pricing is based on the expected income, and it is also the part of the deal that attracts the most negotiation. The buyer estimates the fees it will receive, subtracts the cost of doing the work, and allows for the risk that borrowers repay early or default.
A common shorthand is a multiple of the annual servicing fee, which is then applied to the balance of the loans. Why do companies sell?
Some want to free up cash, some lack the scale to service efficiently, and others want to reduce risk from rate-sensitive income. Buyers, often large servicers, want to add to their portfolios.
The transfer of servicing affects borrowers, although their loan terms do not change. They must be told in writing who the new servicer is and where to send payments.
Good planning avoids missed payments and confusion during the changeover. Be aware that the letters MSPA are used for several unrelated terms in other fields, so the context is important.
Here the meaning is the mortgage servicing contract.
In practice
Real-world examples.
Example
A regional bank decides to focus on lending and sells the servicing of 10,000 home loans to a specialist servicer. The MSPA sets a price of $6,000,000. The bank uses the cash to fund new loans, and its customers are told in writing who will collect their payments from the transfer date.
Example
A specialist servicer buys servicing for a pool of loans and finds the borrowers prepay faster than expected. The value of the purchase falls below the price paid. The servicer learns to model prepayments more carefully and to price its next purchase with a lower multiple.
Example
A mortgage company discovers that some loans in a pool it sold were not made according to the agreed standards. The buyer uses the MSPA to demand a price adjustment of $250,000. The seller pays after reviewing the evidence, because the agreement clearly states how such breaches are resolved.
Formula
Calculation
Purchase Price = Unpaid Principal Balance x Servicing Fee Rate x Multiple
Suppose a servicer sells the rights to a pool of loans with an unpaid balance of $500,000,000. The annual servicing fee is 0.25%, and the agreed multiple is 4.0. Annual fee income = 500,000,000 x 0.0025 = $1,250,000. This is the income the buyer would collect in the first year if no loan were repaid. Purchase Price = 1,250,000 x 4.0 = $5,000,000, which equals 1.00% of the balance.Case study
Seen in the real world.
Parkside Lending is an illustrative, fictional mortgage company that needed $8,000,000 to meet a capital requirement. It decided to sell the servicing on $2,000,000,000 of loans.
The finance director negotiated an MSPA at a price of 0.40% of the balance, which gave 2,000,000,000 x 0.004 = $8,000,000. The agreement included a clause allowing the buyer to recover part of the price if loans were repaid within 12 months.
The sale gave Parkside the capital it needed but removed a stream of steady fee income. Annual fees of 2,000,000,000 x 0.0025 = $5,000,000 were handed to the buyer. The illustrative lesson is that selling servicing brings cash now at the cost of income later, and the contract terms on early repayment need close reading.
Watch out
Common mistakes.
- Believing a sale of servicing changes the borrower's loan terms, when the rate and payment stay the same.
- Pricing servicing on the loan balance alone, when expected prepayments and default costs strongly affect its value.
- Ignoring the representations in the agreement, when they decide who bears the loss if a loan was badly made or if documents are missing.
Questions
People also ask.
What does an MSPA cover?
It covers the sale of servicing rights for a set of mortgages, including the price, transfer date and each side's promises, together with remedies if a promise proves untrue.
Why would a lender sell servicing?
To raise cash, reduce risk or concentrate on lending instead of collecting payments.
How does a transfer affect me as a borrower?
You receive a notice telling you the new servicer and payment instructions, but your loan terms remain the same, and payments sent to the old servicer during the changeover are normally honoured for a period.
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