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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