Did you know that mortgage brokers get money at a wholesale cost? Just like your local Nordstrom’s, we buy at wholesale and sell at retail. The only difference is that we, acting as a mortgage broker have to tell the customer three times what we expect to profit on their mortgage transaction: First, within three days of an application on a good-faith estimate. Then, within three days of drawing loan documents (same disclosures). Finally, on the HUD-1 Settlement Statement as a paid outside of closing (POC) item.
That profit, paid by the lender to the broker is called yield spread premium or YSP. You can understand it as “negative points”. If a consumer pays discount points to lower the rate, why then couldn’t they receive points (as a credit towards closing costs) to accept a higher rate ? Instead of paying an upfront charge in the form of a discount point, they receive an upfront credit in the form of a yield spread premium.
Let me give an example:
If a mortgage broker wanted to earn a fee of 1% of the loan amount plus $495 processing fee on a $400,000 loan, there are 3 ways that broker can earn it. Let’s assume that the third-party costs are $4,000. Total costs, including the mortgage brokerage fee would be $8495.
1- The customer could choose a rate of 5.875% with no yield spread premium paid by the lender. The customer-paid fees will be the mortgage brokerage fee of $4,495 PLUS the $4,000 third party fees for a total of $8,495. All fees are paid by the consumer.
2- The consumer gets a rate of 6.25% with 1% yield spread premium, paid by the lender, to the mortgage broker. The consumer-paid fees will be $495 PLUS the third party $4,000 for a total of $4,495. The lender will pay the mortgage broker the other $4,000 of the fee.
3- The consumer gets a rate of 6.625% with a 2% yield spread premium, paid by the lender, to the mortgage broker. The mortgage broker keeps $4,495 and credits the remaining $3505, from the yield spread premium, to the borrower for all of the third party fees. That’s enough to include the title insurance premium, “lender junk fees”, appraisal, etc .
Why would a customer want to pay a higher rate if he qualifies for a lower one? Because it lowers his upfront loan costs.
Isn’t the mortgage payment going to be higher? Of course it is! In the difference between option one and three , that difference is $250/month, or $3,000 per annum. The borrower receives $8,000 upfront in negative points for that $250/month. The mortgage broker asks the customer if they intend to keep this mortgage for more than 32 months (the breakeven point). If they say, “No, we’ll probably refinance to remodel”, then they should take the negative points and higher rate. If they say. “Yep. We expect to be in this loan until we pay it off”, then the mortgage broker should advise them to pay the third party fees and the mortgage brokerage fee upfront and accept the lower rate.
If a consumer borrows from a direct lender (or bank), that lender (or bank) is not required to disclose the profit it earns to the consumer. A mortgage broker is the only type of loan originator that offers true transparency in lending; an unbiased comparison of loan programs where the profit is fully disclosed.
Yield Spread Premium is a way for borrowers to lower the upfront closing costs on their loan transaction. When a consumer understands how it works and negotiates a mortgage brokerage fee prior to the loan application, he/she can truly get a good mortgage solution without the fear of “secret profits”.
Last 5 posts in Costs and Fees
- What is Your Mortgage Handicap? - December 3rd, 2009
- Does a Broker Have to Legally State Yield Spread Premium if Asked? - December 3rd, 2009
- New Refinance Break-Even Point and Savings Graph - October 1st, 2009
- Renovation Financing: Not all loan officers are created equal! - September 23rd, 2009
- Tips & Tools for First-Time Buyers - September 17th, 2009
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- Categories: Costs and Fees, Mortgage Broker
Comments
12 Comments so far
Andy Jolls
Brian, I love this post. In my experience the challenge is that consumers aren’t told about the options in many cases. I tried to get a lender to be upfront with me as Scenario 1 costs far less to the consumer.
A $250,000 loan at 5.875% will mean $282,384 paid over the course of the loan.
A $250,000 loan at 6.250% will mean $304,145 paid over the course of the loan.
A Difference of $21,761.
Compare that to the $4,000 I could pay instead.
My sense was most lenders prefer the $21K, so they push for this scenario. That’s why consumers are benefited from your tutorial on YSP!
John (Tampa LEO)
Hey Brian: We spoke about one month ago in reference to rates and points. I have definitely learned alot about mortgages and rates in a very short time. I also wanted to Thank you for your knowledge earlier. FYI…We got a 6.0% lock with 1/2 point origination. It does not look like MBS are going to break through the ceiling within my time frame of closing. Thanks Again John
Brian Brady
Andy,
In your case, it looks like the breakeven for that $4,000 fee is 68 months. If you were to stay IN THE LOAN, for 5.5 years or more, it makes financial sense to pay that $4 grand.
John,
I’m ecstatic for you. If memory serves me correctly, that’s .5% lower in rate and fee than what you were offered at the end of October.
I enjoyed our conversation and wish I could have helped you personally. Still, I’m glad the “coaching” worked out for you
Diane Tuman
Brian: Thanks for explaining how YSP works. How do you figure out the breakeven time frame?
Brian Brady
Let’s take a real life example. While my B/E analysis isn’t technically correct (because of amortization), I”m pretty darned close.
I’m closing a FHA Jumbo at 6.375% next week with 1% cost to the borrower (about $6,000). A no cost loan would be at 6.75%. The difference in payments is $150, or about $1800/year (meaning the higher rate yields a payment that is $150/month higher).
Divide the cost ($6,000) by the monthly savings( $150) to find months to breakeven. $6000/150=40 months)
The client feels that they wont sell or refinance before May of 2012 so they opted to pay the point for the lower payment.
There is a more precise analysis (total cost analysis) but that suggest a 35 month b/e point. It still makes sense to pay the point
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Luther
How is it that a mortgage broker can suddenly tack on a yield spread premium of about 1 point when it was never mentioned in estimated closing costs and never mentioned to the borrower. How is that the customer can go into settlement with only broad estimates and figures that might me as much as 10% - 15% off the actual final closing costs?
Luther
Brian Brady
“How is it that a mortgage broker can suddenly tack on a yield spread premium of about 1 point when it was never mentioned in estimated closing costs and never mentioned to the borrower.”
It’s supposed to be disclosed on the good-faith-estimate, Luther. Many brokers disclose a range of 0-3%, on the initial good-faith-estimate.
“How is that the customer can go into settlement with only broad estimates and figures that might me as much as 10% - 15% off the actual final closing costs?”
That’s going to change next year
Morgan
Good Morning. I need your help on a loan that I am thinking about getting. It is an FHA 30 year fixed. I have a credit score over 700 and little debt. My mortgage is for $184,561. My mortgage rate is 5.50%. The Broker Fee agreement states that the YSP will not exceed 2.20%. Therefore that means that I pay $1845.61 for the broker free, $275 for the processsing fee, and for the underwriting, credit report, tax service $824 which totals $2944.61. The Broker Comepensation that the Lender will pay is $4060.34. I have a sizeable down payment if I need to use it. Should I pay the $4060.34 to that I have a lower interest rate? I realize now why I was given a higher interest rate. I’m not putting down that much money. I plan to stay in the house at least 5 years could be longer depending on the economy. This house could also turn in to an investment property. Thank you so much for all of your help. I’m a first time homebuyer and am trying to learn as much as possible.
Jerry H
Hi Morgan:
In response to your post above.
I need your help on a loan that I am thinking about getting. It is an FHA 30 year fixed. I have a credit score over 700 and little debt. My mortgage is for $184,561. My mortgage rate is 5.50%. The Broker Fee agreement states that the YSP will not exceed 2.20%. (this means it will not exceed and could be lower)
Therefore that means that I pay $1845.61 for the broker free, $275 for the processing fee, and for the underwriting, credit report, tax service $824 which totals $2944.61.
The Broker Compensation that the Lender will pay is $4060.34. (max fee from lender)
I have a sizable down payment if I need to use it.(if you are going FHA and putting down more than 3.5% or say more than 10% you may be better off not going FHA)
Should I pay the $4060.34 to that I have a lower interest rate? {NO, you can not pay more than 1% origination to a broker per FHA guidelines)this is the max upfront fees allowed
I realize now why I was given a higher interest rate. I’m not putting down that much money. (this contradicts your “sizable down payment above?)
I plan to stay in the house at least 5 years could be longer depending on the economy. This house could also turn in to an investment property. Thank you so much for all of your help. I’m a first time home buyer and am trying to learn as much as possible.
5.5% is a great rate and the Broker is not ripping you off even if his total commission is 3.2% remember that Realtor is making 3-6% and if it is a new build the builder may have 5% more added to their commission. It amazes me how no one ever questions the realtors fees which total over 6% on a purchase yet, will shop all over the country for $5.00 less in fees or 0.125% in rate only to have higher upfront fees to get the lower rate.
Real Estate
I can’t believe I missed this information before
Free Loan Modification Kit
Many homeowners do not understand complicated terms of many mortgages and the loan officers would like to keep it that way, b/c that equals more $ in there pockets. Whenever there is a mortgage term you do not understand make sure to ask your loan officer to explain it until you do know whats going on./..