A Guide to Yield Spread Premium

There is a lot of misinformation about a pricing mechanism in the mortgage market called "rebate" or "yield spread premium."  Mortgage brokers will often refer to this term as YSP.

Many people don't really understand the whole "YSP thingy."  This article will hopefully explain to you to check your loan application disclosure documents and the estimated and final HUD-1 Settlement Statement.

Discount points are upfront interest to the borrower.  Along those lines, so are closing costs from third-party providers.  This means that we figure in those costs as the true COST of credit to the consumer and measure it as an annual percentage rate (APR).  There are 2-3 good arguments why APR is an antiquated measure, but that's for another article. Simply, borrowers pay points to lower the rate.  A common term is to "buy down the rate."

Did you know that mortgage brokers get money at a wholesale cost?  It's how brokers make a profit.  Just like your local Nordstrom's, brokers buy at wholesale and sell at retail.  The only difference is that mortgage brokers 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, at the bottom of the itemization (bottom of page 1 of the California MLDS),
• Second, within three days of drawing loan documents (same disclosures),
• And 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 points to lower the rate," why can't they "receive points to accept a higher rate."  Instead of paying upfront interest in the form of a discount point, they receive upfront interest in the form of a "YSP."  That receipt of upfront interest defers the mortgage broker's fee!

Here's an example:

If a mortgage broker wants to earn a mortgage brokerage fee of 1% of the loan amount, plus $495 processing fee on a $400,000 loan, here are 3 ways a broker can do it for a customer who wants to take advantage of YSP (or negative points).  Let's assume that the third party (or HARD) costs of this loan are $4,000:

1. The customer gets a rate of 5.875% with no YSP.  The customer-paid fees will be $4,495 PLUS the $4,000 third-party fees for a total of $8,495.

2. The customer gets a rate of 6.25% with 1% YSP.  The customer-paid fees will be $495 PLUS the third party fees of $4,000 for a total of $4,495.  The lender will pay the mortgage broker the other $4,000 fee, but the borrower really pays it in the form of a higher interest rate.

3. The customer gets a rate of 6.625% with a 2% YSP.  The customer-paid fees are only $495!  The lender pays the mortgage broker $4,495 and the broker credits the remaining $3505 from the YSP to the borrower for all of the third-party fees.  That's enough to include the title premium, "lender junk fees," appraisal, etc.

Why would a customer want to pay a higher rate if he qualifies for a lower one?  The answer is because they receive negative points!  Hey!  What about their payment?  Isn't it going to be higher?  Of course it is!  In the difference between option one and three , it is $250/month in extra interest or $3,000 year.  They receive $8,000 upfront in negative points for that $250/month.  Then, it's a matter of simple math of whether the customer intends 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 I advise them to pay the third party fees and my mortgage brokerage fee upfront and take the lower rate.

If you are used to dealing with a direct lender, correspondent lender or bank, they do not have to disclose yield spread premium to the customer because they are making the credit decision, funding the loan, and reselling it on the secondary market (Wall Street).  If you want to be certain that your customer is getting a fair deal from a direct or correspondent lender (or bank) , ask a mortgage broker to furnish you with a good-faith estimate at identical rates and fees from the direct lender so you can see the "profit" the lender is making.