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YSP is a 4 letter word

By
Mortgage and Lending with First Option Mortgage 269761

Ask a Mortgage Lender how much he/she makes in YSP (Yield Spread Premium) and you may find yourself escorted out of the building. The term YSP was eradicated by the Obama Administration and just mentioning those letters may result in 20 years imprisonment and a $1 billion fine! Okay, not really, but it is forbidden to say the words which should not be spoken. So, while you read this, read to yourself. Don't read it aloud if you are near a financinal institution. You've been warned.

 

Back before the turn of the Millennium and up to 2008, Yield Spread Premium (YSP) was used to make commission on mortgage loans or to help offset mortgage closing costs for purchase or refinancing loans. It was derived from increasing the mortgage interest rate offered by the lender in order to pay the Loan Officer (LO) his/her commission. Those funds could also be used to help pay closing costs for the buyer. The higher the interest rate offered to the buyer, the higher the YSP. The YSP was paid in points. One point is equal to 1% of the loan amount. A Par rate means that the quoted rate neither cost money to the buyer nor did it yield a premium spread to the LO. An interest rate of 5% Par paid zero points. An interest rate of 5.50% may have paid 1.5% of the loan amount. An interest rate of 4.75% (.250% below Par) would cost money to obtain. Each lender paid a different YSP according to the rate offered.

 

At Real Estate closings, LO’s could earn up to 2% in YSP as well as Origination, Discount and Broker fees. The percentage amount could be split between the LO and the buyer, it could all go to the LO or the entire amount could go to the buyer.

 

The cost of the loan depended on several factors including but not limited to the loan amount, credit score, type of loan, amortization of loan, type of property, lender etc. The further complicated the borrower seemed to be, the higher the interest rate and in turn, the higher the YSP. The LO had the choice of earning a zero percent YSP, but more often, LO’s took advantage of someone who had difficulty getting approved elsewhere. During the time of the YSP, sub-prime lending existed and buyers could get loans with the worst credit imaginable, with no job, no money or no citizenship. A borrower with an 800 credit score putting 20% down and showing all documentation as proof to qualify received a better interest rate and lower closing fees than a borrower who had a 580 credit score, filed bankruptcy last year, was self-employed for 6 months and saved his money in someone else’s account.

 

HUD started to realize that people with bad credit, many being minorities, were charged higher interest rates and fees than were people with good credit, many being non-minorities. According to HUD, these loans were being sold to people who couldn’t read or understand what they were getting into and Loan Officers were not making an effort to explain to the buyer what type of loan program they were getting. Some loans were sold to buyers at 13% interest rate using a rate that would adjust upwards after 2 years and if refinanced before 3 years, the buyer would have to pay 6 months mortgage payments as a penalty. Other loans had a balloon payment clause that caused the loan to become due in full within 2 years. Most people who had bad credit couldn’t get their credit in better standing within 2 years and lost their homes. It was just a matter of time before the investors buying these bad loans realized they purchased loans of people who couldn’t make the payment. Those investors would eventually fail to make their payments to the bank that lent them the money to buy the failed loans.

 

After new legislation in 2008 wiped out YSP, banks started using the term, Lender Credits (LC). Today, a bank may offer an interest rate of 3% to a Manager. The Manager adds 1% to 2% LC to him/herself, which increases the rate to 3.75% and then that rate is offered to the LO to quote a buyer. The LO has the ability to use the Manager’s LC in order to offer a lower interest rate than that of the LO’s offered rate. The Manager has to accept getting paid less in order to offer a lower rate to the buyer. This practice is uncommon but it is used on larger loan amounts or if the buyer is key to a Lender relationship with a referring source.

 

While some banks pay the LO a straight 1% of the loan amount for a low offering rate, others lenders offer their Loan Officers a tier system. This is an example of what a rate tier looks like:

 

3.750% = .750 of the loan amount

3.875% = 1.00% of the loan amount

4.000% = 1.25% of the loan amount

4.250% = 1.50% of the loan amount

 

Today, using the tier system, if the LO wants to make more money on each loan, he/she must offer a higher rate to the client. Using the example above, a rate of 4.250% would earn the LO 1.5% of the loan amount in commission income. Some banks require the LO to pick a tier at the beginning of each year and stick to that tier throughout the year. In other words, the LO cannot choose a lower rate and simply be paid less to obtain a lower interest rate for the buyer whenever he/she want to. With the tier system, a branch LO may offer an interest rate of 4.25% and another LO in that same branch is offering a rate of 3.75%. What a mess!

 

Whether a Loan Officer is paid on a tier system or paid a fixed percentage, the Lender Credit is still used to benefit the Loan Officer and/or the buyer.

 

Here’s an example of how Lender Credits are used.  Let’s say that I want to get paid 1.25% on each loan and the rate at the time is 4%. At closing, I will get paid 1.25% of the loan amount. However, I can quote a higher rate (not lower) of 4.25%. What happens to the extra .250%? The extra .250% can either be used as a credit to the buyer to help pay closing costs. It can also be used to help lower the rate on the next buyer. How does that work?

 

Let’s say that I’ve closed the previous loan. I was paid 1.25% of the loan amount. The extra .250% was put into a premium bucket for the LO. The new client says she wants the best rate possible. The lowest rate that I can offer is 4%, however, I can use the .250% from the previous closing, to lower the rate to 3.875% (1.25% minus .250% = 1% and using the chart above, obtains a rate of 3.875%). I will still get paid 1.25% on the loan because I’m using the Lender Credit from the previous buyer to obtain the lower rate. I can also choose to offer my lowest rate of 4% and keep the .250% for another day or I can also use the .250% to help pay closing costs.

 

If I chose the lower commission rate of .750% in order to quote a lower interest rate of 3.75%, I’ll make less money per loan. However, I can offer a higher rate to help pay for closing costs or to defer it for the next loan.

 

With a loan amount of $100,000 in this scenario, if my base rate is 3.75%, I can offer a rate of 4.250% which pays a Lender Credit of .750% (4.25% = 1.50 LC and 3.75%  = .750% LC. The difference between the two is .750%). This LC is equal to $750. Another option would be to use .500% ($500) of the .750% to pay for closing costs and keep the other .250% for the next buyer.

 

You may have heard commercials stating the ability to do a “No Closing Cost Loan”. This is mostly used with refinancing the mortgage loan. Well, now you know how they do the “No Cost Closing Loan”. The lender simply increases the interest rate and uses the Lender Credit to pay for the closing costs. The end result? A much higher interest rate over the term of the loan with little to no out of pocket expenses. Of course, the other option with refinancing is to increase the loan amount to cover the cost of doing the loan. Increasing the loan amount is less expensive than increasing the interest rate since most people can’t afford to pay for costs out of pocket.

 

Call it what you will. Although the term Yield Spread Premium was deleted (most lenders forbid us to call it such), the process of increasing an interest rate to obtain money still exists today and the only difference now is that the LO cannot put that money in his/her pocket.