What Are Mortgage Servicing Rights (MSRs)?

Definition of mortgage servicing rights (MSR)

Mortgage servicing rights (MSRs) represent a contractual agreement between the original lender and a mortgage servicing company. The contract grants the company the right to manage the loan on behalf of the mortgage originator.

The mortgage servicing company charges a small fee for its services. Its duties usually include collecting payments, managing escrow accounts, answering the borrower’s questions and more.

Outsourcing these tasks allows mortgage lenders to free up additional time, money and resources so they can generate more mortgages and increase their profits.

Example of an MSR

Imagine you've spent several weeks searching for the perfect home and lender and finally decided to apply for a mortgage. You make a 3% down payment, and things go smoothly for the first few years as you make your monthly mortgage payments without any issues.

However, one day, you get a notice in the mail that your lender is selling the servicing rights of your mortgage to a third party.

While your monthly payment and interest rate will stay the same, you’ll need to send your monthly payments to the new servicer and direct any mortgage-related questions to them.

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How do MSRs work?

Lenders and investors frequently trade mortgages and their servicing rights on the secondary mortgage market. They’re often bundled as mortgage-backed securities. Mortgage ownership can be risky, so the secondary market may be a safer option.

When your lender transfers your MSRs, the new servicer takes over the management of your mortgage. It benefits both parties — the lender saves time and money, and the mortgage servicing company earns a mortgage servicing fee.

The mortgage servicing fee is usually a small percentage of each payment, which the company deducts from the amount you already pay. Typically, the new servicer forwards your payment to the mortgage originator after taking their fee (but not always).

What a mortgage servicer does

When your mortgage lender sells your MSRs, the new servicer takes over specific functions to facilitate the repayment of your mortgage loan.

Here are some of the tasks the mortgage servicing company performs:

• Collecting monthly payments
• Sending statements each month
• Issuing principal and interest to payments
• Handling fees for mortgage insurance
• Taking care of property taxes
• Managing escrow funds
• Fielding questions from the borrower

If necessary, the mortgage servicing company can also handle a default or foreclosure.

How MSRs are created and transferred

Mortgage servicing rights are created when a lender originates a home loan. At closing, the lender typically gains the right to service the mortgage, which means collecting payments and managing the loan after it is issued. The lender can keep those rights or sell them to another company.

Here’s how the process usually works:

1. Loan origination: A borrower closes on a mortgage with a lender.
2. Servicing rights established: The lender receives the right to service the loan under the mortgage contract.
3. Decision to sell: The lender may choose to sell the servicing rights to free up cash or reduce risk.
4. Sale and transfer: A buyer purchases the MSRs under a servicing agreement that outlines duties and fees.
5. Regulatory compliance: The transfer must follow federal and state rules, including consumer protection laws.
6. Borrower notification: Borrowers are notified in writing before and after the servicing transfer.

Who buys and sells MSRs, and why?

Several types of financial institutions buy and sell MSRs. The most common participants include:

• Banks and credit unions
• Nonbank mortgage servicers
• Mortgage real estate investment trusts (REITs) and investment firms

Lenders sell MSRs mainly to increase liquidity and manage risk. Selling servicing rights allows them to recover cash faster and focus on originating new loans.

Buyers purchase MSRs to earn steady income from servicing fees. Because borrowers make monthly payments over many years, MSRs can provide predictable cash flow. Large servicers also benefit from scale, since managing many loans can lower costs per account.

How do MSRs affect borrowers?

Typically, a change in mortgage servicer doesn’t have much impact on the borrower's day-to-day experience. The most significant difference will be where you send your payments.

“If your MSRs change, you'll receive notification from both the new and old servicers,” said Misha Mikhaylov, the CEO of Llama Loan, a small business financing company. “This will include new payment instructions and details about your escrow account, so it's critical to review these documents so you can avoid missing a payment on accident.”

While your monthly payment and loan interest will remain the same, MSRs may affect new loans offered by mortgage lenders.

“In terms of interest rates, MSRs can have a minor impact through the secondary markets,” said Mikhaylov. “For example, if there is a higher demand for MSRs because of the stability they can provide, this could entice some lenders to offer more competitive rates and originate more loans.”

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