Mortgage Excess Servicing What It Is How It Works
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Mortgage excess servicing is a fee based on the monthly cash flow of mortgage-backed securities (MBS). It is the amount left after dividing the cash flow into a coupon and principal payment for the MBS holder.
Key Takeaways:
– Mortgage excess servicing is a fee paid to mortgage servicers for the maintenance of MBS.
– The excess servicing is what remains after deducting regular mortgage servicing fees.
– Mortgage excess servicing can arise from bundling mortgages into an MBS with different originators or servicers, each charging a different rate.
A servicing fee is a percentage of each mortgage payment made by a borrower to a mortgage servicer. This fee compensates the servicer for record-keeping, collecting and making escrow payments, and passing principal and interest payments to the note holder. Servicing fees range from 0.25% to 0.5% of the outstanding mortgage balance each month. The mortgage excess servicing fee goes to the loan servicer and may act as a guarantee fee for the MBS underwriter.
In a typical MBS deal, if the mortgage interest rate is 8%, the MBS holder receives 7.5%, the mortgage servicer receives a 0.25% servicing fee, and the MBS underwriter gets 0.15%. The remaining 0.10% (8% – 7.5% – 0.25% – 0.15% = 0.10%) is excess servicing.
Mortgage excess servicing for MBS is affected by prepayment and extension risk. The value of excess servicing is estimated based on the expected duration of the annuity. Changes in interest rates can significantly impact the value of excess servicing.
Mortgage excess servicing may arise when mortgages are bundled and sold. If the buyer does not service the loan themselves, they may enter into a servicing agreement with the originator or a third party. The servicer retains the right to receive part of the interest payments made by borrowers.
A mortgage servicing spread represents interest retained by the servicer and is considered reasonable compensation for services performed. Any portion of the mortgage servicing spread that exceeds reasonable compensation is called excess servicing spread and represents an ongoing investment in the underlying mortgage pool.
The Internal Revenue Service (IRS) has ruled that ownership of certain mortgage excess servicing spreads is a real estate asset. Therefore, income from excess servicing spreads is treated as interest on obligations secured by real property. This ruling applies to real estate investment trusts for tax purposes.
