Mortgage brokers' sleight of hand - Boston Globe
I came across the above article yesterday and felt compelled to add my 2 cents to it. Yet again, us mortgage brokers are being portrayed in the media as crooks. The major problem I see is that most written articles and news segments about the mortgage industry are coming from people who know nothing about the mortgage industry and who tend to key in on the bad element of the industry. The article I'm referring to is an Op-Ed piece written by Elizabeth Warren, a professor at Harvard Law School, which pertains to Yield Spread Premium. Excerpts from the article will be posted here in bold.
IN THE past five years, if you called a mortgage broker when you were about to buy or refinance a house you may have been told, "We can check with lots of lenders so you'll get the best price." Because you are a careful shopper, this sounds good - one-stop comparative shopping. The broker most likely didn't add, "I'll take a bribe to steer you to the loan that is more expensive for you and more profitable for the lender."
As a mortgage broker I do not use Yield Spread Premium to steer a client into a more expensive loan. Yield Spread Premium is the markup from the wholesale rates we mortgage brokers receive from the lenders themselves. Often times I receive a 1% to 1.5% Y.S.P from the lenders wholesale division where the rate is still lower than if the client went directly to the lender. Yield Spread Premium is far from a bribe and its intended purpose was not to increase profit for mortgage brokers.
There are brokers who take what amounts to a bribe from a mortgage company to steer a client into a higher-priced mortgage than it could qualify for, all the while assuring the client that this is the best possible deal.
The practice is sufficiently widespread that the bribe has a technical name, a "yield spread premium." The yield spread premium is a payment the mortgage company makes to the broker to persuade the broker to sell the homeowner a higher-priced loan.
The ultimate blow is that often the buyer who has been defrauded will end up paying the bribe as additional "points" added to the closing costs.
Let's take a look at how Yield Spread Premium actually works. Using the professor’s math I will explain further. Let's say I have a client who is purchasing a single family home in the amount of $400,000 with a down payment of 20% for a loan amount of $320,000. Below are actual rates from one of the lenders I do business for the above purchase transaction as well as the principle and interest payments for each rate for a loan amount of $320,000.
7.125 102.000 = $2,155.90
7.000 101.750 = $2,128.97
6.875 101.500 = $2,102.17
6.750 101.125 = $2,075.51
6.625 100.875 = $2,049.00
6.500 100.500 = $2,022.62
6.375 100.250 = $1,996.38
6.250 99.500 = $1,970.30
The rates are to the left and the numbers to the right represent the pricing. 100 means a par rate meaning that the lender will not pay me Y.S.P. (Yield Spread Premium) A rate with a number below 100 means I would have to pay the bank a percentage to obtain the rate for my client. If my client wanted the rate of 6.25% my client would have to pay .50% of the loan amount of $320,000 or $1,600. Anything above 100 means the lender will pay me a rebate or Y.S.P. My client actually qualifies for a rate lower than 6.25% but of course the client would have to pay for the rate. As the article is about Yield Spread Premium I will not get into rate buy down.
As the professor is calling Y.S.P. a "lender kickback" I will show you how it's not. After meeting with my client we discover that his threshold for a monthly P.I.T.I (Principle + Interest + Taxes + Insurance) is $2,455.90 a month. The mortgage payment at 7.125% is $2,155.90 a month plus taxes and insurance of $300 a month totals $2,455.90 a month.
The highest rate my client qualifies for is 7.125% but of course he qualifies for a much lower rate. However, as wants to have some money left over after closing for some minor home repairs as well as reserves he does not want to part with any more than $90,000 (The 20% down payment of $80,000 plus total settlement fees of $12,800 = $92,800) As the client only want to part with $90,000 and total costs of the transaction are at $92,800, my client will be short to close by $2,800.
As a mortgage broker I am compensated in one of three ways.
1. By the lender via Y.S.P.
2. By the client via a mortgage broker fee.
3. A portion by the lender and a portion by the client.
The client has made it clear that although he realizes that I need to be compensated he does not want to pay a mortgage broker fee. I have explained to my client that my normal compensation for a loan such as his is 1% of the loan amount. He agrees that 1% to me would be fair compensation. If I were to charge him a mortgage broker fee of 1% of the loan amount I would be adding an additional $3200 to his settlement fees (1% of $320,00) and increase his settlement fees to $16,000 ($3200 fee + $12,800 in closing costs) which would bring his total out of pocket expense to $96,000. He has already made it clear than he is not going to pay a penny over $90,000 to close the transaction. Now as I am compensated in one of 3 ways and my client will not compensate me himself I have no other choice then to be compensated by the lender.
I fully explain the payments to my client and we agree on how I want to structure the loan and what the pros and cons will be. My client agrees to close on a rate of 6.875% as I will use a portion of the Y.S.P. to pay down his closing costs. A rate of 6.875% on a loan amount of $320,000 has the lender compensate me 1.50% or $4,800. However, the client does not want to part with anything above $90,000 and total costs of the transaction are $92,800. I simply use a $2,800 of my $4,800 in lender compensation to lower his settlement fees from $12,800 to $10,00 and my compensation from $4,800 to $2,000. My client is happy that his total out of pocket expense target of $90,000 was met and I'm happy that he agreed that $2,000 in compensation from the lender to me was satisfactory.
Had my client chosen the rate of 6.75% I would have mad $800 in compensation after paying down his settlement fees and a rate of 6.625% would have left me with zero compensation. I hope you all know see how Y.S.P. is not a kickback but a way for mortgage brokers to be compensated and also, on occasion, lower the cost of a transaction.
A vice president of Fannie Mae has described the premiums as "lender kickbacks," but the practice remains legal. The additional costs for the bribe are slipped into the closing document as part of the closing costs. Under pressure from the mortgage-broker industry, Congress and the regulatory agencies have generally approved of yield spread premiums. In fact, mortgage brokers face few regulatory restrictions.
The reason the practice remains legal is because making the practice illegal would provide borrowers with less financing options. I hope you all can see that from my rather lengthy client example above. Y.S.P. is not added to the closing costs. In fact Y.S.P. is disclosed on a HUD-1/Settlement statement as (P.O.C. = $2,000). P.O.C. = Outside of Closing. The only increase in actual cost of the loan is the per diem interest which is rather minimal. For example, had my client chosen a rate of 6.25% as opposed to the rate of 6.875%, the difference in 30 days of per diem interest would be a whopping $166.66 or approximately $5.56 per day of per diem interest. As far as restrictions are concerned, if I fail to disclose to my client that I will be receiving Y.S.P. and actually receive it, I have to return the full amount of the Y.S.P. plus fines from my state banking department.
Now I can continue to pick and comment from the article but I won't. There is no clear cut answer as how to stop the bad element of the mortgage industry in gauging clients by taking a maximum Y.S.P. rebate from the lender and also charging a client a mortgage broker fee as well. The point of this blog post is to make people realize that Y.S.P. has a purpose and a use and because there are people out there who misuse it doesn't mean it should be made illegal.
Just once, I would love to see an article or news segment about a happy homeowner who used the services of a mortgage broker. I doubt the day will ever come so I'll just keep adding client letters of satisfaction into my trusty old binder.
;)
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I just finished reading the article (see also mis-infomercial) entitled "Mortgage broker's sleight of hand" by Elizabeth Warren and I am extremely disheartened that the Globe would publish a story based on the opinion of someone with the obvious lack of knowledge Professor Warren has on this subject. Although I am sure Professor Warren in proficient in some aspect of life, thereby securing her a job as a Professor of something at Harvard, in the future the Globe may want to ensure their writers have either have a working knowledge of, or do some research on, the specific topics you allow them to write about. Although I could probably fill a short book with responses to the points Professor Warren is wrong on, I will highlight some of the most extreme.
Yield spread premium (YSP) is no more a "bribe" than Professor Warren's monthly paycheck. YSP is income given to a mortgage Broker from the lender they are securing the loan with, for their borrower accepting a higher rate. The YSP, as a general rule, is roughly 1% for every .25% higher the client pays for a 30 year fixed rate (in contrast to Professor Warren's implications, the spread is usually LESS on ARMs). Here's the educational part: mortgage loans are not free! Companies that write loans, whether they are banks/brokers/lenders get paid to provide that service. When you are working with a broker, they are working with the wholesale rates from the lenders they do business with. Wholesale meaning there is NO income on the base rate. Brokers can then either charge up-front points, collect money from the bank in the form of YSP or any combination of the 2. Because of the way that wholesale rates work, YSP is present on the vast majority of all brokered loans, whether your credit score is 850 or 550. The reason YSP is on 85-90% of the sub-prime business is because a sub-prime client generally does not have the up-front money to pay a mortgage broker, therefore the broker makes their income in YSP. Another point I noticed was missing from Professor Warren's article is that the Yield is also often utilized to pay a client's closing costs. For instance on a $300,000.00 loan; if the broker is offering a client 6.5% and getting 1.5% in YSP to do so, the broker can pay 1% ($3000.00) toward the client's closing costs and still profit .5% ($1500) on the loan.
Thankfully, as Professor Warren stated, help is on the way! Wait, I'm sorry...help CAME already. I have been in the Mortgage business coming up on 12 years now and, to my knowledge throughout that entire time, mortgage brokers have been required to adhere to the Home Owners Equity Protection Act (HOEPA) of 1994 which regulates the amount of total fees that can be charged on a Mortgage loan. Amendments to that act, that have come along well over 8-9 years ago, require that yield spread premium be clearly stated on the Good Faith Estimate and the HUD Settlement Statement reviewed with an attorney at closing. In addition, there is a Massachusetts Attorney General's Disclosure that details EXACTLY how much a client is paying the broker, how the broker is making their money and what amount of YSP is being paid to the broker. The Truth in Lending statement given to the borrowers up front and again at the closing also details EXACTLY how much the loan will cost the borrower over time. If Professor Warren is knowledgeable enough in this industry to be writing an article, certainly she is aware of these 4 most basic mortgage documents.
I'm not sure if Fannie Mae's "statement" (more than 50% of sub-prime loans could have been qualified as prime) is something Fannie Mae actually said or not. What I do know is that THEY were the ones that decided whether or not the loan qualified. Fannie Mae is the agency that ultimately writes the guidelines used for the approval software that the lenders adhere to. If Fannie Mae is stating that all those loans qualified, then why didn't they approve them?
I'm particularly amused at the example the Professor gave regarding brokers "pushing" clients from a 6.5% to 9.5% and "pocketing the difference". Well, let's use the example above as a reference; if every .25% more on a rate grosses the broker an additional 1% in income...why then, if you were a morally defunct broker wouldn't you get them qualified at Fannie Mae's 6.5% and sell the 9.5% and profit 12% in fees??? The answer to that question is, of course, because it is over the legal (and heavily regulated) limit of income by about 7%. What even the most unscrupulous broker would do instead is give their client a rate of 7.5%, hit their maximum profit and still look like a super-hero.
Although I know I will not make any friends with this statement, let's all stop sugar-coating this problem because of the masses involved and put the blame where it belongs; on the consumer. If you took out an adjustable rate mortgage in order to buy a home you couldn't afford and gambled on the rates never going up, you were wrong. If you financed that home at 100% because you didn't have any money to put down, you were wrong. If you applied for a stated income loan because you KNEW that you wouldn't qualify if you used your actual income, you were wrong. If you had credit issues and, instead of taking care of them first, you chose to take advantage of the more liberal underwriting to get into a home faster, you were wrong. But now that it comes time to pay up; the ones with no savings, bad credit and not enough income to afford the home that they have been lucky enough to live in for the past 3-5 years are going to point a finger at the mortgage industry and say WE were irresponsible...shame on you!
In closing, Globe, please police your "writers" a little bit better. This is the sensationalism-based/factually-void writing that stops us all from reading the Herald.