What the Heck is a Yield Spread Premium (or, YSP)?

Buying a house and working with a mortgage broker or lender? Refinancing? Ever wonder how much money mortgage brokers can make on your transaction?

Preamble

I was half-watching CNN this past week and was drawn to a segment that featured a Harvard University economics professor who was explaining that the mortgage crisis is not being caused by sub-prime loans, but rather by mortgage broker steering and profiteering. To loosely paraphrase, the mortgage crisis is happening because many mortgage brokers put their clients into loan programs at higher interest rates than they qualified for and, if they had used their "real" rates, many families facing foreclosure would still be able to afford their monthly payments.

For the last several days I've been thinking about this story and started to research Yield Spread Premiums. I found a lot of confusing examples and labyrinths of legislative code that only helped to exacerbate my growing belief that some mortgage brokers take horrible advantage of their clients.

In writing the journal entry, I'm hoping to deliver a concise, easy to understand definition of YSP that will help you make educated, intelligent mortgage choices and decisions.

My Mortgage Broker Drives a Bentley and lives in Beverly Hills

Getting a good loan can be a slippery slope. At the highest level, all loans include fees and costs, but there may also be negotiated rebates that the mortgage broker will receive from the lender as part of their compensation. These rebates can be 2,3 or even 4% of your loan amount—the mortgage industry's underbelly is not pretty!

For example, maybe your credit isn't perfect and you've worked with a mortgage broker to lock you into an 8%, 30 year fixed, $1,000,000 loan—congratulations! But, here's what might be happening in the "back room." Maybe you actually qualified for a 6.5% loan and your mortgage broker "steered" you into the 8% program. When the loan closes, the lender will rebate the mortgage broker the delta between the wholesale rate you qualified for and the rate that was sold to you. In this case, $15,000. This rebate is also known as the Yield Spread Premium (YSP).

Caveat Emptor

Now that I've caught your attention, here's my only caveat. NOT ALL MORTGAGE BROKERS ARE ROGUE AGENTS and most are honest, ethical professionals. In very general terms, most honest mortgage brokers will generate income equivalent to 1% of the loan amount (give or take a little.)

Is the YSP Always a Bad Thing?
No, absolutely not. When working with a mortgage professional who puts your needs ahead of their desire to sponge money from you, YSP's can be used for:

• To help pay closing costs
• To help offset cost on a refinance
• To cover fees, costs and expenses in a "0" point, "0" fee loan
• To compensate the broker for particularly difficult and  time consuming loans
• Plus 101 other legitimate reasons

YSP is absolutely a fantastic tool when used with the knowledge of the borrower or for the borrowers benefit.

When is the YSP a BAD Thing?

• When the lender or mortgage broker try to hide the rebate
• When the lender or mortgage broker put there financial gain 100% ahead of your needs
• When a mortgage broker is dishonest with you about their fees
• When a mortgage broker puts/steers you into a loan program that is at a higher interest rate than you qualify for

What  Some Mortgage Brokers Say About YSP:

• This is how we make our money
• It's paid to us by the lender and as such, the "client" shouldn't care*
• Without rebates mortgage brokers will go out of business

Another example

Michael the mortgage broker recently assisted his client in securing a "great" interest rate after shopping the client's "package" within his pool of investors and lenders. As listed in Michael's Good Faith Estimate, he was to be compensated $2,500 for his mortgage broker services. In addition to the broker's commission, the good faith estimate listed several other fees and 3rd party costs.

Because interest rates are still near historic lows, Michael was able to lock this client into a 6.5% loan—which seemed like a fantastic deal, right?

Here comes the tricky part. Because of the time-line used by lenders to complete loan packages, the client won't see their full loan disclosure until they are signing loan documents, which normally happens a few days prior to the funding and closing of a deal. For Michael's client, there was a line item paid by the lender to the mortgage broker for $18,000. Of course the client was ecstatic that the lender was paying the $18,000, no-harm-no-foul and the client goes forward with the loan (ouch)!

What's really happening in this $18,000 windfall example?

*This is a 1% Yield Spread Premium at work. Without the YSP, the client should have received a 6% interest rate. Over the first five years of the loan, the extra .5% represents a whopping $43,000 in extra interest.

One last example

Diana and I know a couple who called us recently because they wanted to refinance their home. We recommend California Fundings' Dennis Shaffer (310.678.0075). Our client talked to Dennis, but was swayed to use a nationally known direct lender by the president of the company they work for. When they went to sign their loan documents, there were a few line items that Todd and his wife didn't understand, and the mortgage broker couldn't explain.

Todd hit the brakes and called Dennis for help.

In reviewing the loan documents from the nationally known mortgage company, the local "senior" loan consultant who put their package together had hidden almost $30,000 in rebates. To add insult to injury, the lender added a significant prepay penalty and redacted this fact within Todd's version of the contract.

The Bottom Line

• Interview several lenders and mortgage brokers, find one you trust and like
• get a written good faith estimate from the lender, including YSP's, commissions, and fees that the mortgage broker will be making off of your transaction. Remember, the mortgage broker is working for you and they make money off of your transaction.
• Get everything in writing
• Want to make sure you're lender is treating your fairly, get Dennis Shaffer to review your loan docs. Better yet, give Dennis a chance to capture your business.

With knowledge comes power, and it's true that many mortgage brokers depend on their YSP rebates to make a killer living. For this group of lenders, we can hardly contain our giddiness and joy that they'll soon be back in their previous careers of selling cars and working in the restaurant industry. For honest and ethical brokers, we wish them continued success and a growing business—it's all about fair and balanced lending.

Seasoned lenders with years of proven success under their belts have the knowledge, expertise and relationships needed to achieve a reasonable balance between their profits and your need to secure your best possible interest loan.