“Yield spread premium,” or YSP as it’s known in the industry, is the fee (commission) paid by the mortgage lender to the broker in exchange for a higher interest rate, or an above market mortgage rate. Though the borrower may qualify for a mortgage at a certain interest rate, the broker or loan officer can charge this fee and give the borrower a slightly higher rate to make more commission.
This practice was originally intended as a way to avoid charging the borrower any out-of-pocket fees, as brokers could earn their commission and cover closing costs with YSP. However, many feel the intentions have been misguided, with yield spread premium ending up as just another fee the borrower gets stuck paying. Be careful to review your HUD-1 or Good Faith Estimate to see how much this fee is, and why it’s being charged.
Also note that the verbiage can vary, and yield spread premium may read as “par-plus pricing”, “rate participation fee”, “service release fee” and so on. Make sure you go over each fee to ensure you don’t get duped!
Careful You Aren’t Charged Twice
You shouldn’t be charged a substantial amount on both the yield spread premium and the loan origination fee. It’s hard to say what’s too much and what’s too little because every loan is different, but keep an eye on the fees and ask why they’re being charged.
Also keep in mind that a broker may split up his or her fees by charging a half percent in the yield spread premium and another half percent in loan origination fee. This wouldn’t mean the broker is necessarily charging you twice. Their commission is simply being broken up, with some money coming out-of-pocket and some coming in the form of a higher mortgage rate.
If you’re buying down your rate, there should not be any yield spread premium, since you’ll actually be paying discount points to lower the rate on the back-end. Of course, this means you’ll need to pay a commission as well, so it can get pretty expensive if you go after that low, low rate.
Yield Spread Premium Used for No Cost Loans
Banks and brokers will also charge a yield-spread premium as a way of providing a “No Closing Cost” loan. Basically, the bank or broker will charge a YSP large enough to offset any upfront fees the borrower would have to pay, and still end up with enough money to make a decent commission.
An example would be a broker that charges no mortgage points or fees, but charges a YSP of 2% on a $400,000 loan. The total compensation to the broker is $8,000, and the fees associated with the loan may be $3,500.
The borrower won’t have to pay the $3,500 in fees as it will be subtracted from the broker’s YSP of $8,000, leaving the broker with $4,500 net commission. It sounds like a good deal, but the interest rate the borrower ultimately receives will be substantially higher than it would be at the par rate.
There is a lot of controversy surrounding yield spread premiums, and an ongoing fight between mortgage brokers and institutional lenders. Brokers must disclose the YSP, whereas institutional lenders can avoid disclosing it as their yield spread may not be determined until a later date when the loan is sold on the secondary market.
Be sure to compare and contrast different scenarios and combinations of YSP and loan origination fees – both are negotiable, and don’t necessarily need to be charged to begin with.