The Federal Housing Finance Agency (FHFA) has asked Fannie Mae and Freddie Mac to help develop a new system for compensating lenders who manage mortgage accounts, in the wake of complaints that the current system can actually promote foreclosures.

The two government-supported enterprises, as they are known, were asked to consider alternatives to current guidelines for mortgage servicing and the way mortgage servicers are paid for managing home loans. The Department of Housing and Urban Development (HUD) will also be involved.

The stated goals of the new guidelines and compensation structure would be to improve service to borrowers, as well as reducing financial risks for lenders and giving guarantors more flexibility in handling delinquent loans, i.e., facilitate loan modifications for borrowers in financial difficulty.

Unlike historic mortgage arrangements, most home loans today are not held by the lender who first made the loan. Instead, they are sold to investors as mortgage securities, with mortgage servicers taking on responsibility for collecting payments, corresponding with borrowers and enforcing the terms of the loan.

Servicers are typically paid a fee based on the mortgage interest rate and loan balance, as well as having "servicing rights" that enable them to earn additional revenue through late fees, interest on funds held in escrow and the like. They can also earn certain fees for foreclosing on delinquent loans.

One of the complaints about the current servicing fee structure has been that it can make it more profitable for a servicer to foreclose on a delinquent loan, rather work out a loan modification to bring it current. The servicer may therefore have an incentive to foreclose, even when a modification might be in the best interest of the investor owning the loan, not to mention the homeowner.

As the recent problems in managing mortgage delinquencies suggest, the current servicing compensation model was not designed for current market conditions," said FHFA Acting Director Edward J. DeMarco. "The goal of this joint initiative is to explore alternative models for single-family mortgage servicing compensation that better address the needs of borrowers, servicers, originators, investors and guarantors."

Any new guidelines are not expected to be implemented before summer 2012 at the earliest.

Published on July 7, 2008