How Loan Servicing Works

Loan servicing can be carried out by the bank or financial institution that issued the loans, a non-bank entity specializing in loan servicing, or a third-party vendor for the lending institution. Loan servicing may also refer to the borrower's obligation to make timely payments of principal and interest on a loan as a way to maintain creditworthiness with lenders and credit-rating agencies.

Loan servicing was traditionally seen as a core function held within banks. 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 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.