Oftentimes, when we hear the word “mortgage” we immediately associate it with a contractual loan obligation between a home buyer and lender. That’s true. However, what many people fail to realize is that the interaction between those two stakeholders is only the tip of the iceberg. A typical mortgage is paid over a 30-year period and during that time, many different things can impact a homeowners’ ability to pay back a loan (ie job loss, health problems, divorce, etc) which is why every mortgage, no matter the type, needs to be serviced.
In its simplest form, mortgage servicing is the process of collecting interest, principal and escrow payments from a borrower. Some bank and non-bank lenders service their own loans while others outsource to third-party servicers. Given most mortgages are sold in the secondary market to government sponsored entities (“GSEs”), such as Fannie Mae and Freddie Mac, and given GSEs do not service the loans they purchase, the original underwriter or its third party servicer will typically service the mortgage on behalf of the GSE and retain mortgage servicing rights (“MSRs”). In exchange for collecting and managing mortgage payments, servicers are typically paid a monthly fee per mortgage serviced.
Over the last half century or so, and as the US housing stock and subsequent mortgage volume increased, lenders needed a way to service those loans. As a result, lenders and third-party servicers traditionally hired more people rather than leverage technology to service those volumes. To a certain extent, people-intensive workflows can work, and it has until now, but, at a certain point, bloated overhead has an adverse impact on margin expansion, end pricing and service quality. Now let’s be clear, mortgage servicing is easier to automate when borrowers actually pay their monthly mortgages on time. At that point, it’s making sure funds are routed correctly and in a timely manner. However, it can get more challenging and nuanced when payments aren’t met or late. Each borrower’s situation and circumstance is unique so often times servicing has and most likely will continue to require a human element to understand the degree of risk and determine appropriate next steps. That said, technology should have a bigger impact on mortgage servicing productivity levels than it has had to date.
Over the last year or so, technical founders have discovered the challenges associated with this market, studied potential solutions and started building relevant technology to turn the current paradigm on its head. We’ve seen new mortgage servicing startups take one of two approaches: 1) selling SaaS to existing incumbents or 2) building proprietary technology and becoming a tech-enabled, vertically integrated mortgage servicer. Upon initial review, selling SaaS might seem like the most advantageous approach seeing as though valuation multiples of publicly traded SaaS companies are hitting all-time highs largely driven by the recent “Great Acceleration” of software adoption brought about by the advent of COVID-19. However, selling SaaS in this particular part of the built world ecosystem may have its drawbacks. For example, traditional mortgage servicers tend to be tech adoption laggards making it difficult to sell to them and to convince end users to actually use the product. In addition, traditional mortgage servicing is a low margin business so adding extra layers of costs on top may not jive with current incentives. If software is purchased it may actually force the mortgage servicer to increase their end customer prices which may put new stress on existing relationships and inadvertently force customers to take their business elsewhere.
As a result, and to bring about much needed breakthrough change, new mortgage servicing technology may require a completely new perspective. This leads us to believe that vertical integration might be the most advantageous go-to-market strategy. Tech-enabled vertical integration is not new to the built world. Compass revolutionized the approach in single family residential brokerage. Bowery Valuation followed in commercial appraisal. The idea is to develop proprietary software and keep it “in house” whereby only allowing W2 employees use it. Utilizing a vertically integrated approach, an expert human remains in-the-loop. The technology is not meant to fully replace humans but rather make them more productive, more efficient and able to do more with less whereby expanding gross margins and allowing for cheaper retail price points with more reliable and less error prone, high quality service.
One of the biggest challenges with the built world is how relationship driven it is and the mortgage servicing sub-sector is no different. Some lenders and third-party servicers have been working together for decades so relationships and trust run deep and may make it difficult, at least initially, for new vertically integrated approaches to break in. However, as soon as mortgage originators realize how much cheaper tech-enabled vertically integrated mortgage servicers are compared to incumbent counterparts, all it will take is one lender to take a chance on a vertically integrated servicer before the domino effect will kick in. If one “falls” then the rest will follow ultimately resulting in many new efficiencies and lower costs across the ecosystem.