Understanding Yield Spread Premium and the Congressional threat

Yield spread premiums may be the most misunderstood facet of the retail mortgage industry. They are receiving a disproportionate share of blame as a result of this misunderstanding. If some in Congress have their way, the mortgage brokerage industry will be significantly jeorpardized and consumers will suffer.

Two bills pending in Congress target yield spread premium. In the House, HR 1728, is scheduled for full vote next week. In the Senate, SR 896 a bill addressing mortgage modification with amendment 1015 to ban all yield spread premiums and SR 912 a bill specifically to ban yield spread premiums. 

I am writing another post about this issue because of new developments in the Senate with respect to SR 806 and SR 912.

Today I received a follow up call from the very gracious Victoria Johnson, incoming Membership Chair for the NAMB, in response to a previous post in which I falsely charged Denise Leonard with agreeing at a testimony before the House Financial Services Committee, that yield spread premiums are a kick back. Ms Johnson did testify before the committee, but she was not asked any questions and did a wonderful job representing the industry position.

Another person who I would expect to have a better understanding of yield spread premiums however did accept the misleading association of yield spread premiums. The representative from the Federal Reserve was asked if yield spread premiums were a kick back, and her answer was, "Yes."

The question was asked in the context of an example, a unrealistic and misleading example in my mind, of a broker steering a qualified buyer who might qualify for a 5% rate loan to accept an 8% interest rate loan. The reason for such steering is so that the broker will receive a huge "kick back" from the subprime lender.

Her answer and even the framing of the question reflect a misunderstanding that we, industry professionals, need to attempt to correct.

I am unaware of such examples actually taking place, even when subprime loans were available. Certainly in today's market such a switch is not possible. There may have been some brokers who were not approved FHA and could not offer that product, but most brokers who could offer FHA and subprime would not submit a potential FHA loan to a subprime lender because more money could be made with the FHA loans, even if there were no felt sense of obligation to do the best for our clients. Of course, for most brokers there is absolutely a sense of obligation. 

Congress, many consumer advocacy groups, and apparently many in related industries and agencies think such examples are realistic. It is this mistaken assumption that motivates their action to support legislation that will in the end, harm consumers.

As I write this, there is an amendment being presented in the Senate to ban all indirect compensation in a mortgage loan.

Understand this, there will be indirect compensation. If yield spread premium is banned, then the consumer will just not be able to access that indirect compensation. The banks and secondary market investors will simply keep that premium.

Congress cannot legistlate away the market price for a loan.

For example, a 30 year mortgage with an interest rate of 4.875%, locked for 45 days, with a loan amount of $200,000.

One lender may pay a premium of 1/2 point ($1,000). Another lender may pay a premium of 1/4 point ($500). Another lender may not pay any premium ($0).

The borrower has the same rate with all three lenders, but has the access to three different premium structures. If the broker needs to charge a total of 1.5% ($3,000) to stay in business, then with lender 1 the broker can charge $2000 (1%) in fees. The upfront fees will increase with the other two lenders.

With a bank loan, the borrower would get the same or a worse rate. Yet because the bank funds the loan, no yield spread premium is disclosed. The borrower has the same term. The bank will keep the premium with Congressional blessing.

Some of this is difficult to follow, and I apologize. It is much easier for Congress to make up scenarios that create villains. But Congress is not there to take the easy way out. They need to make an effort to understand pricing mechanisms in the mortgage security market.

If they do not come to an understanding they will increase consumer cost, reduce consumer choice, and increase bank income.

Contact your Congressional representative. Here is a link on the NAMB website to find your representative.

Banning payment of yield spread premiums will not change the market price that secondary investors will pay for a mortgage loan. It will only change who will receive the premium. In this case it will go from the consumer to the bank.