Mortgages and Yield Spread Premiums

Abusive lending practices and an uproar over deceptive sales practices in the mortgage industry often focuses on unscrupulous tactics regarding mortgage rates and closing costs that are exploited by loan officers and mortgage lenders.  One such aspect of mortgage lending deceit involves the disclosure of the yield spread premium on the good faith estimate and settlement statement for a home loan. 

The issue was addressed once again when the Federal Reserve Board (the Fed) adopted a number of new rules that involve certain prohibitions regarding good faith estimates regarding mortgage rates and closing costs and for mortgages made on or after October 1, 2009.

These new rules which are a combination of the rules adopted by the Fed and others from the U.S. Department of Housing and Urban Development (HUD) ensure that consumers receive mortgage loan good faith estimates of the costs of a mortgage earlier in the mortgage application process and that the disclosures better explain the costs of the home loan and terms of the loan.  The disclosures will cover areas such as the potential for monthly mortgage payments to rise, any prepayment penalty the mortgage loan may have for paying off the loan early, and any fees that may be paid by the mortgage lender to a mortgage broker for originating or bringing in the loan business.  This last aspect is what the industry refers to as the yield spread premium.

Yield spread premium disclosures apply mostly to mortgage brokers but in certain cases it may also be a requirement for mortgage lenders or correspondent lenders as well.

 A yield spread premium (YSP) is a payment the mortgage broker may receive from a mortgage lender when they sell or deliver the mortgage loan to the lender.  A mortgage broker’s job is to facilitate the origination and processing of a mortgage loan.  The mortgage broker may close the home loan in their name but ultimately the loan is funded by a mortgage lender.  The mortgage lender pays the broker the difference in the mortgage rate and points that are required by the mortgage lender to fund or purchase the loan and the mortgage rate and points charged to the home loan borrower by the mortgage broker.  

Technically, the yield spread premium is the dollar value of the difference between the lowest interest rate a wholesale mortgage  lender would have accepted for a given mortgage loan transaction and the mortgage rate a mortgage broker induces or sells the borrower to agree upon.  The greater the spread between the two mortgage rates, the higher the yield spread premium payment to the broker. 

As an example, if a mortgage broker handles a borrowers request for a home loan with a rate of 5.5% and two points and the mortgage lender agrees to fund that same loan at a mortgage rate of 5.5% and 1 point, the difference between the two points charged and the one point the mortgage lender takes to fund the loan has is the brokers compensation or profit.  Often the difference involves the mortgage rate and/or the points charged. 

When the mortgage rate quoted by the mortgage broker is higher than the mortgage rate agreed to be the mortgage lender, the difference is the compensation to the broker which is referred to as the yield spread premium.  The spread between the two mortgage rates, the rate charged the borrower and the rate the mortgage lender will agree to buy or fund the loan at, is paid as a percentage of the loan amount to the broker.  If the mortgage broker quotes a very high mortgage rate of 6.50% and the mortgage lender is willing to fund or buy that same loan with a rate of just 5.00%, the yield spread premium would be very high.  That is an extreme example that would not often be done.  However, yield spread premiums are often a considerable amount of the mortgage broker’s income.

Many critics of the mortgage industry have charged that yield spread premiums amount to kickbacks that give brokers and other loan originators financial incentives to steer consumers to higher rate home loans.  Clearly the federal government believes there are abuses with yield spread premiums as evidenced by the new disclosure rules and in fact, the issue of abuse in yield spread premiums and proper mortgage rate and cost disclosures is a topic visited by the federal regulatory agencies as well as state regulatory agencies in the mortgage lending industry regularly.