Most in the mortgage servicing industry believe that prepayments are a financial risk that needs to be hedged. I would suggest, however, that prepayments represent a marketing risk first and foremost.

While prepays are never ideal, the cost to a servicer of an unanticipated payoff is greatly mitigated if their origination arm recaptures the refi or purchase money mortgage. While the mortgage company has the write-off of the servicing basis on that loan, it is gaining a new loan with a greater servicing value, as well as any gain on sale of the newly originated loan. The real problem is when a pay-off results in a new loan to a competitive mortgage company.

There are three major reasons why you may lose a customer to a competitor¹:

1. The borrower is pulled away by a better price.
2. The borrower is pushed away because of inadequate service, or
3. Worst yet, the borrower does not even know who their servicer is.

All marketing problems.

If I were to ask you what brand of credit card you have, the answer would be AMEX, Visa, etc.

If I asked about your soda preference, you might respond Coke or Pepsi.

If I asked you what kind of mortgage you have, you would probably respond 30 year fixed or 5/1 ARM.  You would give me a product description, not a brand … there is little branding in the mortgage industry.

Branding has many tangible benefits:

• Branding simplifies buying - Given the dizzying array of product features, it is oftentimes safer to go with a known brand.
• Branding ensures consistent quality – am I getting the right product for my unique situation, will I be able to close on schedule, is my rate-lock at any risk?
• Branding encourages repeat purchases – mortgage “purchases” used to be very infrequent.  That is no longer the case.  We have trained our borrowers to refi frequently.
• Branding increases market share – the mortgage industry is still a highly fragmented industry selling a commodity-like product.  Differentiating your product through promotional clarity and ease of access is far preferable to pricing leadership.
• Branding reduces elasticity of demand (i.e., price sensitivity).  Most of the major brands believe their name alone allows them to price their products a bit higher than their competitors.

Financial solutions to the prepay risk should be the last resort. By developing a sound marketing strategy that includes customer recapture and retention measures, a natural hedge can be created within the mortgage company. Implementing such a strategy requires collecting recapture/retention data monthly.

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¹Dr. Thomas J Healy, “Bringing Brands to Mortgages; Mortgage Banking Magazine, March 1996 [reprints available]