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A Brief Explanation of Yield Spread Premiums – Predatory Lending at Its Best

September 5th, 2007 by John Campbell

As I began to learn more and more about the mortgage industry, one of the fees that troubled me most was the Yield Spread Premium (YSP).  The name alone made me scratch my head.  “What is a yield spread,” I wondered.  I’ve since learned what it is, and why a “premium” is associated with it.  Below, I try to lay it out in simple terms.  I warn you though- if you don’t deal with real estate transactions very often, of if you just get mad when people get cheated, you might want to sit down to read this. I should also warn you that real estate transaction lingo is a little like alphabet soup.  If you get lost, you can check out a basic glossary of terms by clicking here.

A YSP is a payment paid by a lender directly to a broker (the person who “helps” the borrower find a loan).  On the HUD-1 form the YSP is almost unrecognizable. (A HUD-1, pictured above, is the long form document you’ve seen if you ever bought a house.)  The YSP is cryptically described in fine print on one line as something like “YSP to AMQ - $450.” The “$450” doesn’t even appear in the charges column since it isn’t paid directly by the borrower.  “Wait a minute,” you might be thinking, “Why do I care about a YSP if it is a payment from a lender to a broker?  It isn’t coming out of my pocket.”  That is where you are wrong. Read on.As mentioned, A YSP is paid to a broker by the lender.  This is in addition to the “origination fee” and other fees which are also paid by the lender to the broker as compensation for the broker’s work.  Why is a lender willing to pay extra money to a broker? The answer is simple: The broker has managed to give the lender a more valuable loan.

Here’s how.  A $100,000 loan with a fixed rate of 8% over 30 years has a specific value to the lender.  The lender can anticipate how much it will make over the life of the loan.  Also, if it wishes, it may choose to sell the loan instead of hanging onto it.  The lender would be paid a price on the loan based on what another investor was willing to pay for the right to collect payments every month for 30 years.  Of course, if the loan had a rate of 10%, it would be more valuable because it would return more interest over time.  Here is where the YSP is “earned” by the broker.

Let’s assume that a borrower tells a broker they need to borrow $100,000 for a house.  The broker does some shopping around (or goes to their favorite lender) and finds a lender that will qualify the borrower for the loan at 8% over 30 years.  This is fine for the broker, and alright for lender, but the loan would be more valuable to the lender at 10% instead.  The lender suggests to the broker that if he or she can place the borrower in a 10% loan, it will pay a bonus to the broker. (Actually there are charts which show that bonuses to the broker will increase based on how high they can pump up the interest rate.)  This “bonus” is a Yield Spread Premium.  In essence, the broker is paid a bonus for giving the borrower a worse loan.

Is this disclosed to the borrower? The answer is “of course not.”  If a broker told a borrower that the broker was profiting at the borrower’s expense, the borrower would walk away or demand the lower interest loan.  Typically, the broker simply presents the higher interest loan to the borrower.  They never mention the deal with the lender or the better rate for which the borrower qualified.  Instead, the only place the YSP could be discovered is on the HUD-1 and maybe on the Good Faith Estimate (GFE) given to the borrower when they first apply for the loan.

Why would a YSP be legal at all? The US Department of Housing and Urban Development (HUD) has addressed this question.  HUD explained in a 2001 statement that sometimes YSPs are an incentive for a lender to make a low fee loan to borrowers in exchange for a higher yield over time.  The idea is that the lender is willing to take less cash up front in exchange for more cash over time generated by a higher rate.  In this way, a YSP is really a bonus to the broker for finding a creative way to get hard working people into loans without needing cash up-front. (To read the whole statement click here.)  This is a plausible explanation for the legality of YSPs, but in loans I’ve reviewed for clients it is not the norm.  Often, customers are charged thousands of dollars in “origination fees” and “appraisal fees” and “document preparation fees” and “courier fees,” and then they are charged a YSP on top of that.  The broker makes off like a bandit, and the borrower is left with a worse loan than their credit would merit.

This is a deceptive practice, and companies should be held accountable for it.  To make matters worse, YSPs are not always disclosed to borrowers in the Good Faith Estimate required under the Real Estate Settlement Procedures Act (RESPA). (To read any section of RESPA, click here.) As a result, even if a savvy consumer - maybe one who read this post - is looking for the YSP, they won’t find it when shopping for the loan.  This was the basis of a class action filed against NovaStar Mortgage Inc. in Washington.  Fortunately for consumers, the case has survived attacks by the defendant and has been certified as a class action.  With a little luck, people who were subjected to YSPs and not even given the fighting chance to catch it on their GFE will be able to recover their damages.

So that is the scoop on YSPs.  If you have financed or refinanced a home or condo, you might want to check your documents to see if you have been charged a YSP. If you find one, and you have questions, please feel free to give me a call or click here to email me.

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