Fees and costs: It's time to redefine reasonable
The road ahead for mortgage servicing must include a new set of transparent business practices
Editor's note: This column was written by a mortgage banking industry insider with over 20 years of experience, who wishes to remain anonymous. The views expressed herein are the views of the writer.
For anyone who has ever traveled to Hawaii and gone into a grocery store, you have likely been shocked by the cost of staple goods. If you think about it, it makes perfect sense that hamburger meat in Hawaii costs more than it does in Texas. Likewise, it makes sense that a pineapple is better priced in Hawaii than in Alaska. Overall, markets generally work that way – price reflects actual costs.
But not all markets work the same: some bundle their costs for the sake of simplicity. For example, consider the postage stamp. The cost to mail a standard letter from Maine to California is the exact same as it is to mail it to your next-door neighbor. The US Postal Service figured out a unified cost that makes sense to them and for all consumers — a flat fee to mail a standard letter, where some lesser-expensive mailings subsidize the cost of more expensive mailings.
(Granted, the USPS hasn’t been able to manage its finances correctly as of late – but that isn’t necessarily due to their pricing strategy.)
In the world of mortgage servicing, common-sense business practices have ruled the day for some time — flat-rate bundling of various products and services has been the predominant approach for vendors for decades, due to servicer and investor requirements that value stable and predictable pricing.
This common sense approach, however, could soon be turned on its ear. That’s because recent events within the servicing industry have challenged common business practice — and that means that everything that has been done in the past now needs to be re-examined, rationalized, and made transparent.
At a minimum, the servicing industry now has to ask:
- What is a “reasonable fee” and who defines “reasonable?”
- What is a “reasonable profit margin?” Can you make too much money on something?
- Does a flat-rate pricing strategy make sense or should the industry revert to an actual-cost model?
- Can industry providers bundle fees, or must we price a la carte?
- Is it acceptable to have an affiliated business? What about a joint venture?
- If you buy a volume of one good or service, can you get a discount on another?
- Is lowest cost still the only variable that matters, or do we now need to factor in the financial strength and viability of the service provider as well?
- Is it acceptable for different consumers to pay different fees for the same service just because their loan is owned by a different investor or serviced by a different service company?
- Who defines the product required (and at what price) when the consumer pays – do you need an appraisal, BPO, or would an AVM suffice – and when are each allowed?
In reality, the answers to many of these questions have for decades largely depended on who pays the costs. And if it’s a simple business cost, it may not matter.
But where costs are passed along to a consumer, the industry is now learning that this does matter. And in a big way, too. But where that line sits remains uncomfortably unclear for many.
How do we define reasonable?
The question of “reasonable” can be scary to tackle — that’s because reasonable to one person may not be reasonable to someone else.
“Reasonable” is also something that can come with a whole host of caveats based on multiple variables. “Reasonable” is often something tested at trial over time, and often a contentious subject in any contract dispute.
As it stands today, what’s considered “reasonable” in terms of servicing industry business practice is subject to new scrutiny — and something that needs industry focus.
It may not seem reasonable at first glance for a service provider to make a 60% profit margin on one service, for example — but what if that same service provider makes a negative 10% margin on another service, and based their pricing model on what works overall?
Many businesses, even those outside of loan servicing, operate this way. Consider a restaurant: the profit margin on an iced tea far exceeds the profit margin on your entrée for example. Or computer hardware: your desktop printer might be sold at an outright loss, while ink cartridges for that printer are a high-margin profit center for the manufacturer.
What really should matter here, hopefully obviously, is that the overall profit margin is acceptable for the business.
While this makes sense, the risk faced by the servicing industry right now begs the question of whether a consumer should be responsible for paying more for one product in order to subsidize a loss leader elsewhere. (Again, remember: this issue only matters when costs are passed through to the consumer.)
Flat rate or actual cost?
As a best practice for decades, servicers predominately pay flat costs for products that include BPOs, appraisals, inspections, property preservation work and foreclosure postings. A flat cost for an inspection at $15 or a BPO of $100 makes sense for forecasting and planning — but does it make sense for everyone involved that a borrower in Houston, Texas pays the same as a borrower in Anchorage, Alaska?
The actual cost of that product is not the same in both markets, and this same issue applies to any product or service where the actual cost will vary based on location.
Flat costs make perfect sense for investors and servicers when looking at a large blend of work and where they wish to normalize spending levels. To achieve a flat rate, however, there will be instances where the actual root cost will be higher or lower than the flat rate charged.
This is good for most in total — think Happy Meal pricing versus a la carte — and can be great for the investor/servicer in the instance where the flat rate is less than actual cost. But the market is now learning first-hand that problems arise in the instance where the real cost was lower than the flat amount charged.
This is doubly true based on who actually pays the charge: if it’s the consumer, look out below.
Affiliated businesses and joint ventures, oh my!
It’s a common practice in nearly any business to have affiliated business units. If a business buys a certain product from a third party, there is a natural thought process to consider doing that work directly, paying the same cost, and enjoying the profits that had been previously going to a third party. American capitalism is rooted in the principle of vertical and horizontal integration of markets.
Joint ventures are another common business tactic that achieves similar ends. As with affiliated businesses, it’s often just plain smart business to look for opportunities that are focused on revenue and profit improvement.
Look at it this way: consumers going into their local restaurant make their choice based on price, quality, etc., of the final product and are not concerned if the restaurant owner happens to also own the wholesale provider of their produce.
The practice of owning an affiliated business may be acceptable in many industries, but the mortgage servicing industry is discovering there may now be limits to the practice that didn’t exist before.
Integrated business units are now only acceptable (or “reasonable”) if they do not cost the consumer more than an unaffiliated business would for similar products or services — or if the profit retained on the associated product/service is deemed “reasonable.”
The obvious question then becomes: who is the arbiter of “reasonable”?
The GSEs? The CFPB? Various state Attorneys General? The FDIC? The FHA? The Treasury? Various settlement monitors now in place? Insurance commissioners? All of the above?
When buying a product or service, cost is certainly one factor — but it’s never the only factor. Quality of the product and financial strength of the service provider are critical components, or ought to be.
You may be able to buy a product for less money, but that product may not be as comprehensive as a similar product that costs a little bit more. Take title products as one example: for instance, a one-owner search costs less than a two-owner search, but the information is not nearly as robust and can ultimately result in future added costs.
It’s often more valuable to the business to obtain the more extensive (and comprehensive) product, but perhaps the cost of that accretive value should not be passed along to the consumer – because the value is accrued to the business, and not to the consumer.
Who draws that line, and where exactly does it get drawn? Without certainty, nearly any provider in the space is leaving themselves open to a liability with an order of magnitude greater than the sum of their entire business in many cases.
Another critical factor that needs to be considered when buying any product or service is the financial viability of the provider. Anyone who has purchased a knock-off product understands the well-worn adage: you get what you pay for.
The same principle applies to products and services in the mortgage space — and there is often clear value in paying more for a product and service from a company with financial viability to back their offering.
While this is clearly a prudent business practice, the mortgage industry will need to define acceptable standards — or have them defined, at some point — otherwise the entire industry risks claims that a particular product and/or service could have been had for less elsewhere.
But my neighbor got it for $15!
Pricing in any marketplace is complex — just ask any economist. In the mortgage marketplace, pricing often depends on a myriad of factors including the overall scope of services required, risk profile, service levels, volume, system integration, and geographic profile.
Whether there are curtailment risks or service penalties can also factor into the cost of a product.
Are there system integration costs or invoice submission costs? Perhaps there is a custom requirement to the product that needs to be considered in implementation.
All of these things — and many more — will go into a pricing decision, and in the end all make perfect business sense. At least, usually they do. But what about when a pass-through cost is sent to a borrower on a reinstatement quote, how does the borrower factor it into the cost they pay?
If a consumer is talking to their neighbor about what they were charged for an inspection, how does that consumer know if they should have paid $15 or $20 for that inspection?
Answer: they often don’t. And the pricing mechanisms behind the price shown often extend well beyond just that single inspection.
Business decisions and business solutions are typically established based on a complex set of rules. The investor profile, risk profile, or particulars of a situation will dictate products and services offered and at what prices — as I’ve hopefully made very clear throughout.
The only catch in this process occurs if the cost of a solution is passed through to the consumer. After all — as yet another example — the consumer may find the value provided from an AVM is good enough and they may not want step up to the cost of a BPO or Appraisal.
Is that the consumer’s call to make against the investor’s collateral, since the cost is passed on to the consumer?
A generation ago, the mortgage business was relatively simple compared to where we stand today. The industry has evolved and there is no question that the consumer is far better off with access to both the liquidity and efficiencies of the current mortgage market structure.
But despite these changes, the mortgage industry’s common notion that “we have always done it this way” has to be questioned.
We have witnessed some shocking developments in the past few years that support the need to revisit and rationalize standard practices. And it’s not at all wise that we wait and react when the next shoe drops – nor is it wise that we as an industry allow adverse actions to dictate new standards.
The status quo and our industry’s inaction leave us in a scary place. As such, we must leverage our strong trade groups — and there are a number of them — to work more closely with regulators to create transparent business practices that measure up to the standards required in today’s market.