I was going to write something on how to read Good Faith Estimates (GFEs), but an article on CNNMoney.com caught my eye. As you know, I have been pretty critical of the mainstream media in their reporting of mortgage issues. Mainly because they don't have a freaking clue. This article is yet another piece that is so full of misinformation all I can do is just shake my head. Journalist have really got to do a better job sourcing information and really understanding the issues they are writing about. However, I guess this is what you get when you have english majors who have never done anything but journalism writing stories on business topics.
The CNN article is about Yield Spread Premiums (YSPs). YSP is how mortgage brokers are compensated. Basically, it is compensation paid by the mortgage lender to the mortgage broker for delivering a mortgage loan at a certain interest rate. The best way to think about YSP is as a profit margin. In short, the Wholesale Interest Rate plus the Yield Spread Premium paid to the Broker equals the Retail interest rate. For those of you with low reading comprehension skills, put another way:
Wholesale Rate + YSP = Retail Rate. Simple enough, right?
For the life of me, I cannot figure out why this concept is so hard to understand? In predictable fashion, the article characterizes the YSP as some evil "kickback from lenders in return for steering consumers into more expensive loans - a problem that the Federal Reserve failed to address."
Let's address the kickback issue. Why do lenders pay YSP to Brokers?
Lenders pay YSP to brokers because it is cheaper than paying their own workforce for the broker's client. The broker incurs the cost of advertising, marketing, and other business expenses to originate (obtain clients) a loan. In other words, YSP is an incentive to the broker to use that bank's products. The bank has to compensate the broker for their work and YSP is how they do it.
Doesn't YSP raise my interest rate?
Yes and No. Remember, banks offer mortgage brokers WHOLESALE interest rates. The RETAIL interest rate is the rate that includes the YSP. Put another way, Bank A may have 30 year fixed rate loans at 6% with no YSP. This is known as the par rate. However, if the broker sells the client the loan at 6.5%, the bank will then pay the broker say 1% of the loan amount as YSP. At 6%, the broker is not being compensated, so they would have to charge the borrower "points". The borrower is either going to get 6% with 1% in total points or 6.5% with no points. No borrower will ever get 6% with no points as that would put the broker out of business since there is no profit margin either in points or YSP.
The most egregious error in the article though is that it fails to mention that if the broker is offering a borrower 6.5% with YSP baked in, that rate is still cheaper than if that borrower went to the bank directly.
Does the Broker have an incentive to earn as high of a YSP possible by giving me a higher rate?
The last time I checked our economic system is solidly capitalist. When I price a loan I want to make as much profit as possible while remaining competitive. It is the American way. However, at the end of the day, it is IMPOSSIBLE for a broker to gouge a consumer who aggressively shops for their mortgage. If a broker is trying to raise the rate on a deal so they can make 2% in YSP on a deal that most other brokers might do for 1% YSP at 6.5%, it wouldn't take but two or three phone calls to competiting brokers to uncover this as the inflated YSP is going to result in a higher rate being offered than other competitors. It really is that simple.
Why did the Fed ignore the YSP issue in their ruling?
Because the Fed figured out that YSP doesn't matter to consumers. Let's take a little test. You are shopping for a mortgage. Broker A quotes a rate of 6.5%. Broker B is quoting 6.875%. Banker C works for Kuntrywide and claims he doesn't charge the ripoff YSP since he is a banker and his rate is 7%. Broker A does a lot of loans and has a special deal where he gets incentive pricing and will earn a YSP of $8,000. Broker B only gets a YSP of $4,000. Banker C doesn't disclose since banks are treated differently.
Which is the better deal? Broker A making $8k in YSP at 6.5%, Broker B making $4k in YSP at 6.875% or Banker C with the "free" loan at 7%?
If you are smart enough to own a home, you are going to pick Broker A because it has the lowest rate of all the lending choices you had REGARDLESS OF HOW MUCH PROFIT IS MADE ON THE LOAN. You could give a rats ass what he is making. He gave you the best deal out of all the competitors you called.
Real life example. I just closed a loan yesterday and had a YSP of $5200, no points. The borrower asked me to lower the YSP after I disclosed it on the GFE. I said no. The rate was 5.250% on a 5/1 i/o ARM. Why did I say no? Regardless of my YSP, there was no way anyone was going to be able to match that rate. The borrower soon figured it out and agreed. End of discussion. They got freaking good deal and at the end of the day, my YSP was irrelevant because the closest competitor had pricing of 5.75% on the same loan.
At the end of the day, it bothers me that such misinformation is spread around by news sources. Some consumer is going to read this article and think their broker is ripping them off when it isn't the case.
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