WASHINGTON : Curbs Proposed on Mortgage-Servicing Abuses

The $150-billion mortgage service industry has been an unregulated free-for-all. But new legislation has been proposed to impose some regulatory order.

The business sounds simple enough. Like the “servicing” of any consumer product--from autos to washing machines--mortgage servicing is the “maintenance” of a home loan. It involves the collecting of monthly principal and interest payments, administering escrow accounts for the payment of taxes and insurance premiums, and the issuing of annual escrow account statements.

Today’s lenders frequently sell their mortgages. They can sell them “whole” or they can sell them in two parts, the loan and the servicing. It is in the separate sale, or transfer, of mortgaging servicing that problems sometimes arise.

While a borrower has no control over whether his loan is sold or not, if the transfer goes smoothly, the only difference for the borrower will be where he sends his monthly check. But if the transfer does not go smoothly, months, or even years, of exasperation may await.

“It can cause homeowners great anxiety and aggravation,” said Rep. John J. LaFalce (D-N.Y.), who has sponsored the Mortgage Servicing Transfer Act of 1990, a bill to reform the industry. “It can cost them hundreds of dollars and, in some cases, their homes.”

One homeowner wrote the General Accounting Office that after her mortgage servicing was transferred, her insurance coverage lapsed without her knowledge because the new servicer failed to pay the premium. She discovered the mistake when she filed a $21,000 insurance claim and the insurance company refused to pay.

Eventually she filed for bankruptcy and lost the home through foreclosure.

A woman from New Jersey wrote that after her loan was transferred, her monthly escrow payment increased by 50%.

“I am a single woman, working to sustain myself and my family, and I feel if this mortgage company can get away with this ‘legally,’ I will be in default on my loan before next year.”

LaFalce’s bill has been incorporated into the Housing and Community Development Act of 1990, which recently was approved by the subcommittee on housing and community development.

The most common complaint about mortgage servicing, said Mona Findley, who helped prepare a recent General Accounting Office report about the subject, is about the handling of the escrow account. The unwarranted assessment of late fees is another common complaint. Difficulty in communicating with the new servicer is another.

In addition, many borrowers said they had chosen their lender deliberately because they considered it a neighborhood institution because of its proximity to their home or because they had done other business with the firm.

When introducing the original bill before the House of Representatives, LaFalce outlined a typical problem:

“Many borrowers complain that servicers do not provide timely notice of transfers, a failure which often leads to confusion and the assessment of late fees--on the borrower.”

Then he spun out the scenario for his listeners with all its possible and, not uncommon, ramifications:

“The borrower, who mailed his check on time, refuses to pay the late charge. The new servicer simply deducts this amount from the borrower’s escrow account. At some late date when the borrower’s taxes are due, the new servicer finds that the escrow account is short. In the end, the borrower is assessed a tax penalty.”

California Deputy Atty. Gen. Laura Kaplan has seen hundreds of such complaints through the years. “It really hit a peak in the mid-’80s,” she said. “It’s hard to say if it’s getting worse, but I can tell you that it isn’t getting any better.”

The GAO estimates that the volume of mortgage servicing transfers has increased from the $80-to-$90-million range in 1985 to $150 billion in 1988. Some analysts say the savings and loan crisis is responsible for the increase in the business because financial institutions are trying to raise capital by selling servicing rights.

But one of the main reasons is really a smoke-and-mirrors accounting maneuver that Alison Utermohlen, director of residential finance at the Mortgage Bankers of America, explains by using Lender A and Lender B as examples:

“Their activities are virtually identical except Lender A makes a practice of making loans and retaining the right to service those loans. Lender B originates loans but sells the loans ‘whole,’ not retaining the right to service them.

“The next day Lender B turns around and buys new servicing (rights). Both lenders have the same assets and the right to future service fees, but Lender B will have a stronger financial picture because the money he put out to purchase rights is on the balance sheet as an asset.

“Granted, it is very confusing and quite inconsistent. But accounting’s rules and guidelines have evolved over 15 or 20 year, during which time, the mortgage banking industry has changed drastically.”

The problem occurs with such frequency, Kaplan said, because, “We see a lot of companies overextending themselves, taking on too much in an attempt to increase their portfolios.

“They buy servicing before they understand the nature of the loans and what they will need in terms of staff to handle them. Some loans are unique, like HUD’s 235 loans, for which the borrowers’ qualifications have to be recertified annually.”

The mortgage servicing section of the housing bill is the first federal attempt to step into the fray and set minimum business standards and establish penalties for lenders who deliberately disobey the rules.

At the time of a loan application, the bill would require lenders to disclose their transfer practices for the previous three years and plans for the upcoming year. It would also require 15-day advance notice of the transfer and a name, toll-free phone number and a person to contact at the new servicing company.

The bill would provide a 60-day exemption from late fees for customers if they send a payment to the wrong servicer, causing it to be late. It also would require lenders to respond quickly to customer inquiries and provide a clear, annual escrow account statement.

The legislation will establish actual damage and punitive penalties for violations of the act. It would allow borrowers to sue lenders in class-action suits, to force lenders to compensate borrowers for all actual damages and legal fees.

In addition, if the borrower is able to prove that the lender had engaged in a “pattern and practice of non-compliance,” the court could levy punitive penalties of up to $1,000 for each member of the class, with a cap of $500,000 or 1% of the lender’s net worth, whichever is less.

Individuals also could be compensated for actual financial damages, plus $1,000 in punitive damages.

Mortgage bankers have supported many of the elements of LaFalce’s bill as responsible business practices. But they object strongly to the possibility of punitive damages.

“At least with the language of ‘pattern or practice’ it would have to be proven that the lender had engaged in widespread practices in violation of the statute,” said Sharon Canavan, deputy legislative counsel for the MBA.

And for consumers with problems, Kaplan advised giving the company a chance to resolve them first. “Contact the company,” she said. “Put every complaint in writing. Send things certified mail.”

If that doesn’t work, contact the Public Enquiry Unit of the California Attorney General’s office: (800) 952-5225.