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Buzzword: Yield spread premium

Consumer Reports News: July 29, 2009 12:08 PM

What does it mean? A yield spread premium (YSP) is a payment mortgage brokers receive from lenders when they sell a consumer a mortgage carrying an interest rate higher than the lowest rate that a borrower actually qualifies for. 

Technically, the yield spread premium is the present dollar value of the difference between the lowest interest rate a wholesale lender would have accepted for a given mortgage transaction and the higher rate a mortgage broker persuades the borrower to accept. Some or all of this dollar amount is typically paid to the broker by the lender in a lump sum. The greater the spread between the two rates, the higher the payment to the broker. 

Why the buzz? Consumer advocates, some state regulators and other critics have charged that yield spread premiums amount to kickbacks that give brokers and other loan originators financial incentives to steer consumers–especially those with weak credit histories–to high-cost, riskier loans, and helped fuel the subprime mortgage crisis. According to the Center for Responsible Lending, yield spread premiums were included in at least 85 percent of all subprime mortgages, with the amount of a YSP averaging about $1,850 per loan.

Though lenders may use a similar system to compensate their own loan officers when they sell mortgages directly to consumers, the Center’s 2008 study of 1.7 million mortgages issued between 2004 and 2006 found that a subprime borrower going through a broker for a typical $166,000 mortgage paid $5,222 more in interest charges during just the first four years of the brokered loan than if he or she got a mortgage directly from the lender. 

Responding to such criticism, the Federal Reserve Board has now proposed regulatory changes that would prohibit both brokers and loan officers from increasing their own compensation by steering borrowers to mortgage transactions that are not in their best interest. It explicitly forbids any payments to brokers or loan officers that are based on the mortgage’s interest rate or other terms. The memorandum announcing the proposed changes makes it clear that consumers have largely been in the dark about the problem. As the Fed puts it: “Consumers generally are not aware of the loan originators’ conflict of interest and cannot reasonably protect themselves against it.” 

The mortgage banking and brokerage industry is likely to lobby heavily against the new regulations during the public comment period, which extends through late November. “Mortgage brokers probably will say they’re going to driven out of business by these new rules, but I know plenty of brokers who are responsible and make a good living putting consumers in the right kind of loans, so I don’t see how these rules will put anyone out of business other than the bad part of the industry,” says Julia Gordon, senior policy counsel at the Center for Responsible Lending.–Andrea Rock

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