I have not met anyone that did not like to save money. In our personal lives and our businesses, we are incentivized to look for cost savings and a loan servicer is no exception to that rule. In today’s increasingly competitive market for home lending, institutions are rightfully reviewing all items included in their closing statements, looking for every way possible to reduce fees to the borrower. One area many institutions turn to is tax servicing with the idea of bringing this function in house and eliminating the line item from the closing statement completely. While this does provide a minimal reduction in costs to the borrower, this decision carries a significant new burden for lenders including hidden costs and added liability.
There are predictable objections when the discussion turns to servicing a tax portfolio in house versus outsourcing to a professional tax service partner. Some managers may think that the cost to have an internal employee perform the functions is minimal, or that they can be cross purposed to multiple responsibilities. I understand that lenders may feel a lot of pressure to reduce closing costs to stay competitive, and the removal of a nominal fee on a closing statement that is passed to the borrower might feel like the only wiggle room they have. I also understand there are beliefs that a smaller servicer may not meet the portfolio asset size to require tax service to be outsourced per regulatory guidance. The team I work with has three decades of experience in tax service; we have seen the full spectrum of mistakes, liabilities and expenses that can result from trying to handle a highly specialized task alone. Let me break down the hidden costs and risks of keeping tax service in house.
The Real Cost of Employees’ Expertise
Tax service requires a level of expertise in the employee that is responsible for reporting and facilitating escrow payments. There are over 23,000 local taxing jurisdictions in the U.S. and each one has small levels of nuance that may not be readily available in a Google search. Once you find employees that have this expertise, it is important to remember that their expenses are deeper than the salary you present in an offer letter. It is a safe rule that an average employee needs an additional 25 to 30% built into their salary for benefits, insurance and overhead. Depending on the size of your servicing portfolio, you will need to weigh the risks of having these employees dedicated to a single task or dividing their role among multiple areas. For a mid- to mass market lender/servicer, it is unlikely that your costs to outsource to a professional tax vendor would meet or exceed the costs of keeping designated employees in house.
What’s in Your Servicing System?
Through experience, we have learned that most loan servicing systems do not have out-of-the-box features to properly manage non-escrow reporting, escrow reporting and escrow payment facilitation. Some loan servicing systems only have one tax line per loan; when a loan has multiple associated tax parcels – each of which that may have a different tax bill amount or even due date if they are cross collateralized across states – creates huge complications to resolve. There is a cost to modify loan servicing systems, not to mention that custom development requires white-board analysis, build time, testing and quality assurance – all of which require time from your team. If your loan servicing system cannot accommodate this type of workflow management or reporting, you will likely need an employee dedicated to robust Excel files or an access database, these can become difficult to maintain and the probability of errors continue to increase because we are humans, and it is all too easy to accidentally delete a zero.
Managing Agency Relationships
I mentioned there are 23,000 unique taxing jurisdictions. Think of this as a client relationship management role, each of these agencies operates with their statutes, due dates, websites, payment requirements, file requirements, office hours and tax collectors that change over the years. There is enormous maintenance needed to manage changes in payment dates and payment requirements. It will be difficult to explain to your borrower when their escrow balance falls short because the tax collector moved up the due date by three months and you were unaware and could not update the escrow collection schedule in time.
The Costs of Not Knowing
Do not forget budgeting for liability and losses for a portfolio serviced in house. Professional tax service partners typically offer liability clauses in their service agreements that are commensurate to the level of risk they are managing. An example of this would be an escrow reporting and payment error. Here is the scenario: A tax vendor reports a payment due of $10,000 but then a month later the borrower receives a late fee notice in the mail for a $1,000 interest fee because the payment received was short as a result of a tax bill increase that no one was aware of! If you are managing your tax portfolio in house, this is a fee that you, as the servicer, will have to pay. The value of mistakes on residential and commercial portfolios can reach into the hundreds of thousands of dollars and could even result in a full property loss. Mistakes will happen, especially if you are not an expert and you are managing this type of reporting in a noncommercial grade technology platform. It is very challenging to budget for this type of liability and loss.
While you are considering keeping your tax service portfolio in house or bringing it back in house, it is important to consider the hidden costs and liability. To further emphasize the importance, the current events in the world are presenting an obvious case for the need to expand your vendor pool and sourcing partners who have various suppliers. This creates more stability in the event of another debilitating event like the Covid-19 crisis. Additionally, using a tax vendor creates a harmonious balance between the cost and growth of your portfolio. Look at it like this: loan costs should be associated with loans originated meaning the expense stays in line with your origination volume. Using a vendor protects your servicing department from having to make hard choices regarding a full-time employee when your volume takes an unexpected turn, allowing you to scale in a fiscally responsible way.