Author: William J Archambault Jr
Kick backs, hidden cost, back points, HUD (Housing and Urban Development) calls it “Yield Spread Premium” (YSP), money paid by the a lender to mortgage brokers outside of closing. Money paid by the lender to the broker because you got a higher mortgage interest rate. Mortgage brokers are suppose to show this on line 801 of their “Good Faith Estimate” and escrow will show it on the estimated and final closing statements (HUD-1) when closing a loan for a mortgage broker. You’ll never see these “points” on a loan from a bank, mortgage banker. Savings and loan, thrift, or credit union! Several Congressman and Senators have expressed concern over YSP’s in recent years citing undo enrichment of mortgage brokers and their agents. The news media often mentions “kick backs” to mortgage brokers, and yet this practice continues!
First we need to understand mortgage pricing. The traditional bank offered one mortgage interest rate that fluctuated occasionally, after WW II loans often included an “Origination” fee (normally 1 point, 1% of the loan amount) more recently we have seen many additional bank and third party fees. Until about 1973 mortgage banks and mortgage brokers as we know them dealt mostly in “government” loans (FHA and VA) the rates were set by the FHA and VA respectively if these rates were below the current market these lenders added “discount points” to increase the “Yield” sufficiently to make money available. We soon saw wide spread use of these “discount points” to buy-down interest rates on all types of mortgage loans. After 1974 when mortgage brokers began their dominance of the mortgage origination market (current estimates have mortgage brokers originating 75 to 90+% of all mortgage loans) your bank normally had 1 rate and it included 1 origination point, mortgage bankers normally have “the rate” and one “buy down” rate. Strangely, mortgage brokers have many rates in 1/8% increments of rate, spanning 2 or more % interest. This is strange because most money offered by mortgage brokers comes from mortgage bankers, the same banks that offer only, the afore mentioned, two, higher cost, rates to their retail clients. About half the rates available to mortgage brokers were the traditional “Buy-down” rates costing up to 2 points more than the so called “par rate” (no discount cost to the broker) the other half were “buy-up” rates paying the broker up to 4%.
The payments, kick backs, hidden cost, back points, etc... were finally named “yield spread premium” by HUD about a decade ago. It’s not uncommon for a mortgage broker to have available a 6 point spread (4 points YSP to 2 discount points) available on any given loan program. That 6 points on a $300,000 loan means up to $18,000 difference in closing cost, regardless of all the other closing cost. Yet, all that extra cost only means about 2% difference in the interest rate. Most consumers don’t have the luxury of choice, they seldom have an extra $18,000.00. Unless they need the lower rate to qualify for the loan the lowest rates seldom make sense.
A quick glance at the rates and discount points might make you think that you’d always save money after 3 years ( 6 discount points divided by 2% interest reduction) but that’s not true. The idiosyncracies of loan amortization mean that the breakeven point is normally closer to 5 years, not counting the time value of money. In today’s society it’s rare in deed that a mortgage loan actually exists for five years, either the house is sold or it’s refinanced long before the breakeven point.
Yet HUD and certain congressman keep holding hearings about the evil YSP and the abuses by mortgage brokers of this “hidden” cost. Selected witnesses offer tales of over charges and hidden cost they are bone chilling. Claims of over charging abound. The problem is they can’t explain why mortgage brokers originate almost all residential mortgage loans, and why it’s almost always less expensive and more successful to finance with a mortgage broker.
There have been abuses, many of them, you’re more likely to be abused by a broker and or his agent than other lenders, because: there are more of them, remember up-to 9 out of 10 mortgages come from brokers.. These abuses and promises of reform make great head lines. “Reformed” is always an interesting term, it implies you’re better than the un-reformed. The argument is that only mortgage brokers charge YSP, but is it a charge? Yield is the return on investment or the product of an investment. Spread is the difference between cost and return, or gross profit. Premium is something extra above the cost.
In it’s simplest form, if a $100,000.00 loan is at 6.000% it will yield $6,000.00. If the cost of funds is 2.000% then the spread is 4.000% or $4,000.00. If administrate and overhead cost the lender 0.5% then the premium is $3,500.00. YSP is a relatively new term coined by HUD. When most of us went to school if you subtracted cost from yield you determined profit!
Why don’t banks and mortgage bankers have to report their profits and why do we call it YSP? We don’t require any business to report their profits to anyone except to stockholders and the IRS. We have to further define YSP, it is that portion of the anticipated profits the lender shares with the mortgage broker. In that 10% or so of mortgage loans originated by lenders they pay commissions and overhead to their own in-house sales department it is considered cost. It is only when the loan originates with an outside mortgage broker that the commission is called YSP.
Shouldn’t the consumer go to direct lenders to save money? It sounds good but it doesn’t work that way mortgage brokers do most mortgage loans for two very good reasons. Loans from mortgage brokers are almost always less expensive, because of competition! Thanks to mortgage brokers the mortgage origination business is possibly the most competitive business in the country! Secondly, success! Mortgage brokers are able to close more loans because they have more than one source for a loan. When the consumer doesn’t qualify for a banks program he’s turned down, that’s the end of the application. The turned down consumer will never know that several other lenders would take his loan, mortgage brokers will get the loan approved.
Mortgage brokers have all those fees! Yes there are a lot of cost in closing a mortgage loan. Ads are always telling you, you can be finance for only $395 to $995, that’s true. But they are not talking about third party cost! Direct lenders advertising these low closing cost are simply using some of the spread to absorb those costs, mortgage brokers do this all the time using the YSP to off set the consumers cost. Normally the direct lender can avoid showing you the real cost, where the broker will have to show all the cost and issue a credit, he’ll also show the YSP adding to the consumer’s confusion. When a consumer sees a long list of costs he may never notice the total at the bottom of the page may be less than the direct lenders short list. All other terms being equal, the only way to compare loans is to check the amount out of pocket and the monthly payment.
Lenders who paint them selves in to a corner advertising fixed fees (like $395) limit their ability to provide the best loan for the individual. Mortgage brokers have a lot more flexibility to aid the consumer and normally will have a lower rate for any given cost, or a lower cost for any given rate. You have to compare apples to apples!
If Congress and HUD are investigating the evils of YSP, won’t we be better off? A few years ago the same people investigated “predatory lending” a couple of large direct lenders had preyed on a southern state. To cure the problem we now have new law “Section 32.” The new law did nothing to help the people suffering form the “predatory” lenders. What the new law did was to drive more morally cognizant lenders out of the business of helping troubled lenders! If the lender now makes one of these high risk loans they must have the client sign a new form in escrow 3 days before closing that says if you don’t make your payments you could lose your house! I’ve only been in lending since 1969 but I’ve never seen a mortgage or deed of trust, that didn’t very clearly say if you don’t make the payments you could lose the house. The only thing the new law accomplished was to reduce competition in this already expensive field driving up prices, and cause a few people to lose their home or worst because their loan was delayed.
The horror stories are true and all the same. The predatory victim explains: I agreed to pay $1,000/ month, I spent the money, I can’t make the payment, they foreclosed on me! There’s enough sin to go around, who’s more immoral? The lady who spent the loan proceeds knowing she couldn’t make the payments or the lender who should have known she’d never make the payments? The evil YSP story goes like this: I agreed to pay 6.5% , he told me I only had to pay 1 point origination, I found out this YSP thing was the lender paying him 2 points! Where’s the problem, the bank would have given her the same loan for 6.5% at 1 point origination, it’s what she agreed to pay. Consumers never ask the bank what there making The evils of YSP are imaginary but they make great sound bites! We can only hope HUD and/or Congress doesn’t solve a non-existent problem.
Copyright 2005 William J Archambault Jr
About the author: The author: William J Archambault Jr has been in lending and real estate since 1969. He’s a mortgage broker in Las Vegas, NV, He writes about upto the minute investment real estate tempered with the wisdom of our grandfathers. He’s the author of:“One House At A Time/Finding And Buying Single Family Rentals” a book for real estate investors available at http://www.reii.org and “Counting On Your Fingers” a math text book for mortgage l
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