Yield Spread Premium: The Dark Side of Home Loans
Most people never really pay attention to a loan's yield spread premium (YSP). In fact, most people have never heard of it. Loan agents rarely, if ever, mention it. Those who have heard of it, do not understand it. Yet it is one of the most powerful sources of temptation leading one to be unethical in the lending world.
In simple terms, yield spread premium is something you pay for, or get paid back, when your loan interest rate is something other than the best rate (no YSP) you should get. The majority of borrowers get paid back, yet never know it.
When you walk into an office to get a loan, one of two things may be offered depending on whom you choose. If you go to a bank, you will get one of their proprietary loans. If you go to a mortgage broker, you will get a loan from one of the many lenders available to them.
Either way, the compelling power of the dark side exists. A bank has laws that protect it and its ability to hide from you the yield spread premium. Mortgage brokers are technically suppose to disclose any yield spread premium, but have developed fancy tricks to elude you from the truth. Borrowers are not safe at either place, bank or broker.
Earlier I mentioned you get paid, or pay for, the yield spread premium. Most are paid and usually thousands of dollars through the unscrupulous use of the hallowed "rate sheet". On paper, the borrower was paid, but in reality it was the loan officer who was. How did it happen?
Greed is the usual culprit. When looking over the rate sheet for an interest rate to quote you it starts applying its powerful grip on the loan officers' conscious. They could quote you an interest rate that has no YSP and therefore no additional cost. More than likely, a rate that pays you back YSP money in exchange for a higher interest rate will be picked. Unlikely, but sometimes better in the long run, they could offer you a lower interest rate if you were willing to pay it down through the use of yield spread premium.
Most, not all, succumb to the dark side. They will quote an interest rate corresponding to a yield spread premium that "pays you money". The money you get paid is hidden under tons of paperwork and manipulated to become the loan officers commission check. It all happens before your very eyes. In fact, you'll probably sign paperwork saying it is OK.
In my humble opinion, the best way to avoid becoming a victim is to avoid yield spread premium completely. This is how I would do it. First, I would not go to a bank because there is no legal way for me to ever know if I was getting a "no YSP" rate. They can legally tell you there is no yield spread premium due to the legal complexities of banking law. I would go shop the mortgage brokers.
Secondly, before ever telling the loan officer your income, credit scores, occupation, or anything else about what you plan to buy or how; negotiate a firm price for what they will be charging for their services. At the same time, get the cost of all their associated loan fees such as the processor fee, underwriting fee, document prep fee, notary fee, etc. Once you know this costs, leave and go shop another broker.
Stay in control of the situation when asking for these fees. Do not fall to the loan officer's insistance that he/she can not help you unless he/she knows your personal information and financial background. I cannot stress this enough. Giving them this information will give them the tools to manipulate you into a situation where you do not want to be.
Once you find the broker you want to give your business to, return and start the loan application process. This is when you will divulge your personal information, credit scores, and finances to them. They need this information to know which loan will work for you.
Let me backtrack one step. Before starting the loan application process, tell them you will only do business with them if they show you the wholesale rate sheet when quoting you the interest rate. Also, tell them later, when you go to lock-in the rate, you will want to see the most current rate sheet again for comparison. If they are unwilling to do so, be wary that it is probable that they use it to hide what they charge the borrower.
Review the rate sheet to look for the interest rate that has a "price or YSP" closest to 100.000. The number is rarely, if ever, 100.000 but there will be one that will be very close. The interest rate associated with the "100" number is the one that is the "no YSP" interest rate, and the one you want. Repeat this when you go to back to lock-in the rate and see what the new "100" interest rate is. That will be the rate to lock-in.
I wish all people were honest and genuine. Then we could trust everyone and feel confident we were being told the truth. Maybe some day, but for now we should empower ourselves through the use of knowledge. If you don't have it, find someone who does and make sure they do not have a business relationship with the loan officer.
For our buyers, I always offer to review their loan documents with them. It is part of our service to ensure that they have full disclosure as to what they are paying for their loan. Ask Insist that your agent do the same or have them find someone who can. If you are a real estate agent, make sure you do not refer your client to a loan officer for which you later review their loan documents and find a huge hidden yield spread premium. You will find yourself in a precarious situation since you referred your client to this professional. It is better not to travel this road at all.
Still not clear about Yield Spread Premium? Here is a Rick Pelleriti video that may help.
Update Feb 2011: RESPA/Regulation Z changes due the April
Everyone in the mortgage business is scrambling around. No one is exactly sure what is coming down the turnpike.
Will the use of the Yield Spread Premium as an extra "gift" in the loan originator pocket be over with? Will the consumer be the only one losing from these new laws? Are the days of the commission-paid loan officers over? The jury is out, but in the meantime you can read the Federal Reserve Board Compliance Guide yourself. Let's see how you interpret it?
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