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Yield Spread Premiums a Scam?

Yield Spread PremiumsJust say the words yield spread premium to certain people and you will have pushed one of their hot buttons. These people believe the YSP, as it is called in the industry, is a giant rip off.

This article doesn’t delve into its moral, ethical or political facades. That is left for each individual borrower to decide. This article’s purpose is to explain YSP in pure mathematical terms to hopefully help borrowers ask their mortgage broker informed questions.

First, we have to take the term yield spread premium and divide it into its parts. Yield spread is simply the difference between two different yields, or rates. Yield spreads exist in the mortgage world as you might guess.

In investing, the premium is simply the amount by which a bond or stock sells above its par value. But we are talking mortgages and not stocks or bonds so there is a slight difference.

In order to fully explain YSP, we have to explain par rate which is the equivalent of par value in stocks and bonds. The par rate is simply the rate at which the borrower would not pay a premium nor would there be a YSP for the broker.

Let’s use an actual loan amount – $100,000 – as an example and let’s make the loan’s interest rate 6.50% which is where we are in today’s lending environment. To know whether there will be a YSP we must know the par rate.

For our example, we will set 6.00% as the par rate. This means this is the rate at which there is no premium if the borrower qualifies for the 6.00% rate. Hence, the broker would not be paid a dime by either the mortgage company.

Notice I said mortgage company. The reason is the borrower does not pay the YSP.

If you could see a broker’s rate sheet (the sheet with the rates quoted for each type of loan along with the premium or YSP) you would see a dash or 0 after the 6% quote. But if you looked at the 6.50% rate, you would see a number in that column. For our example we will use +1.

Translating the +1 into numbers makes the YSP equal $1,000.00. Any numbers you see on the sheet, in this case +1, are actually percentage points. So, the +1 is 1% of the loan amount which, in this case, equals $1,000.00 ($100,000 X 1%). This is the amount that would be paid by the lender directly to the broker.

Because U.S. law requires full disclosure, the YSP would appear on the HUD 1 Settlement Statement under the heading titled, “POC” (Paid Outside Closing) on page 2. This figure is not put in the column marked “Paid From Borrower’s Funds at Settlement.”

It is done this way because the borrower is not charged the fee directly so it cannot be listed as being paid by the borrower. At the risk of repeating myself, it is paid by the mortgage lender and not by the borrower. The controversy enters because some people believe the borrower does pay the fee albeit indirectly.

The borrower accepted the 6.50% interest rate which is a higher interest rate than the 6.00% par rate for various reasons that best suit the borrower. Theoretically the .50% increase in rate over the life of the loan will be far more than the savings in fees. That’s why people say the borrower actually pays the fee.

As I said earlier, this articles only purpose is to explain the YSP. The right, wrong, ethical, not ethical points of argument are for you to decide. But, to make an informed decision you had to know the ins and outs of YSP.

Now you know.

Comments (9)
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9 Existing Comments
  1. James Keyes said:
    on November 26th at 11:55 am

    This is a pretty good explanation of YSP. There is one tiny error at the end though. You theorize that a borrower would potentially save more over the life of the loan with a lower rate…if the borrower held the loan for 30 years, that might be the case, but two little facts contradict this theory.

    1) No one keeps a loan for 30 years anymore. They are 95% likely to sell or refinance sooner…usually within just 5 years. At that point it makes much more sense to NOT pay the extra broker fee.
    2) Consider the number of shorter term loans. 3, 5, 7 and 10 year loans have become very popular. It makes no sense to pay an extra fee for a loan you will only keep for a few years before refinancing.

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  4. Cindy Gonzalez said:
    on July 9th at 10:49 am

    That is a very helpful explanation. Thanks….Do you know I have asked the question many times and got the run around on the answer. Now I find relief to be able to explain it to my clients with confidence. Cindy Gonzalez, Fl Lic Mortgage Broker, Specializing in Investors Rehab Hard Money Loans in Florida

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  6. Dan Tanner said:
    on July 29th at 11:00 pm

    YSP known as yield spread premiums are declared to homeowners upfront in good faith estimates and are included in the loan papers by law. There is no hanky panky in this. Mortgage products have built in pricing models for different layers of mortgage people in the industry and your mortgage broker/ bank needs to be paid for services when you take out no point loans.

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    James Keyes said:
    on November 26th at 11:55 am

    This is a pretty good explanation of YSP. There is one tiny error at the end though. You theorize that a borrower would potentially save more over the life of the loan with a lower rate…if the borrower held the loan for 30 years, that might be the case, but two little facts contradict this theory.

    1) No one keeps a loan for 30 years anymore. They are 95% likely to sell or refinance sooner…usually within just 5 years. At that point it makes much more sense to NOT pay the extra broker fee.
    2) Consider the number of shorter term loans. 3, 5, 7 and 10 year loans have become very popular. It makes no sense to pay an extra fee for a loan you will only keep for a few years before refinancing.

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