Yield Spread Premiums a Scam?

Just 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.