# Understanding Loan Servicing: Definition, Process, and Practical Example

## What Is Loan Servicing?

Loan servicing encompasses the entire administrative process of managing a loan, from disbursement to final payment. Learn how monthly payments are collected, taxes are managed, and records are maintained, along with a practical example of how servicers earn compensation.

### Key Takeaways

*   Loan servicing encompasses all administrative tasks from loan disbursement until the final payment is made.
*   The process can be handled by the issuing bank, a specialized non-bank servicer, or a third-party vendor.
*   The securitization of loans has made loan servicing less profitable for banks, leading to a growing separate industry.
*   Servicers earn their revenue by retaining a small percentage of each loan payment as a servicing fee.
*   The loan servicing landscape is shifting, with smaller and non-bank entities filling the market once dominated by large banks.

## Understanding the Loan Servicing Process

Loan servicing can be done by the [issuing bank](https://www.investopedia.com/terms/l/loan-production-office-lpo.asp), a non-bank specialist, or a third-party vendor. Loan servicing may also refer to the borrower's obligation to make timely payments of [principal and interest](https://www.investopedia.com/mortgage/mortgage-rates/payment-structure/) on a loan as a way to maintain creditworthiness with lenders and credit-rating agencies.

Traditionally, banks handled loan servicing as a core function. Banks issued the original loan, so it made sense that they would be responsible for handling the administration of the loan. That was, of course, before widespread [securitization](https://www.investopedia.com/terms/s/securitization.asp) of loans changed the nature of banking and finance in general. Once loans—and mortgages in particular—were repackaged into securities and sold off a bank’s books, the servicing of the loans proved to be a less profitable business line than the origination of new loans.

So the loan servicing part of the loan life cycle was separated from origination and opened up to the market. Given the record-keeping burden of loan servicing and the changing habits and expectations of borrowers, the industry has become especially dependent on technology and software.

## Loan Servicing Example

Loan servicing is now an industry in and of itself. Loan servicers are compensated by retaining a relatively small percentage of the outstanding balance, known as the servicing fee or servicing strip. This fee usually amounts to 0.25 to 0.5 percentage points of each [periodic loan payment](https://www.investopedia.com/terms/r/repayment.asp).

For example, if the monthly mortgage payments are $2,000 and the servicing fee is 0.25%, the servicer is entitled to retain $5—or (0.0025 x 2,000)—of each payment before passing the remaining amount to the note holder.

## Key Factors Influencing Loan Servicing Today

[Mortgages](https://www.investopedia.com/terms/m/mortgage.asp) represent the bulk of the loan servicing market, which amounts to trillions of dollars worth of home loans, though student-loan servicing is also big business. As of 2018, just three companies were responsible for collecting payments on 93% of outstanding government-owned student loans amounting to $950 billion from about 30 million borrowers.

Meanwhile, the trend among big [mortgage loan servicers](https://www.investopedia.com/mortgage-loan-servicer-change-8647152) is to slowly back away from the marketplace in response to growing regulatory concerns. In their place, smaller, regional banks, and non-bank servicers are moving into the space.

> **Important**
>
> Loan servicing has traditionally been performed by lenders (big banks), but smaller, regional players, and non-bank service providers are moving into the space.

The mortgage meltdown during the [2007-2008 financial crisis](https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp) brought increased scrutiny on the practice of securitization and the transfer of loan servicing obligations. As a result, the cost of loan servicing has increased compared to the levels seen before the crisis, and there is always the potential for more regulation.

Meanwhile, some loan servicers have embraced technology to try to reduce [compliance costs](https://www.investopedia.com/terms/c/compliance-cost.asp) and there has also been a refocus by some banks on servicing their own loan portfolio to keep the connection with their retail clients.

## The Bottom Line

Loan servicing encompasses the administrative tasks necessary from the loan's origination to its payoff. This process includes managing payments, escrow accounts, and delinquencies, traditionally handled by banks but now also by specialized companies and non-bank entities. The introduction of loan securitization shifted servicing from banks, making it an independent industry where servicers are compensated through fees. Players in the space increasingly utilize technology to reduce costs and meet compliance needs. While mortgages are the most serviced, student loans represent a significant portion of the market. Amid regulatory changes, smaller banks and non-bank servicers are stepping up in a space previously dominated by large financial institutions.