YSPs - Time To End This Secret Tax on Homeownership
There's a dirty little secret in the mortgage industry called a yield spread premium (or "YSP".) Basically, a YSP is a kickback for the mortgage broker - one he earns by upselling you. Say you qualify for a thirty year $100,000 mortgage at 7%. If the broker can sell you the mortgage for 7.5% instead, he gets a tidy payout from the mortgage lender - at 10%, an even juicier one. Conveniently, brokers have no legal obligation to disclose the YSP to borrowers. So the mortgage company ups its profits, the broker takes his cut, and the homeowner gets equity-stripped.
Mortgage lenders and brokers (a.k.a. the people profiting from your overpriced loan) say this is a feature not a fraud. Their story is that YSPs give consumers the "option" of paying higher interest over time instead of higher broker fees upfront. Nice story, but an empirical study done by Professor Howell Jackson of Harvard Law School shows it doesn't work this way in the real world. Jackson testified before Congress that in his experience, "mortgage brokers never describe yield spread premiums as an optional method for financing settlement costs . . . . Rather, borrowers are simply told that their loans will have a certain interest rate, and they never understand that the interest rate is higher than it needs to be."
Think your broker would never do such a thing? In Jackson's study, 85-90% of mortgages included YSPs. These generated an average kickback of $1,850 to the broker per transaction, making YSPs far and away the largest source of broker compensation. And so much for the claim that YSP payouts are innocently substituted for upfront fees. Jackson showed that brokers made off with an average of $1,046 more on loans when YSPs were thrown into the mix. In the subprime market, YSPs are used to even more abusive ends. The Center For Responsible Lending ("CRL") estimates that excessive interest rates cost subprime borrowers $2.9 billion each year, spread out over about 600,000 struggling families.
My vote for a quick Congressional fix - prohibit YSPs altogether. It's too easy for brokers to pull the wool over borrowers' eyes when brokers see all of the mortgage options and consumers don't. On top of the information asymmetry, the incentive for abuse is too strong with brokers making money proportionately as consumers lose it. You'd hope that the broker wouldn't work against his own customer, but brokers, apparently, are far too unscrupulous.
Even if you think some borrowers (Bueller...?) knowingly agree to higher interest rates in exchange for lower upfront fees, that's not a good reason to accept the status quo. At the very least, consumers electing higher interest rates should receive direct dollar-for-dollar credit for this tradeoff. Forget the broker, give the consumer the YSP payout - write the homeowner the check for $3,000. It's his money, isn't it? And if that would take all the fun out of YSPs, maybe this surprise tax on homeownership wasn't so much fun to begin with.
Brokers absolutely have to disclose YSP to borrowers. It's required by RESPA, and enforced by HUD. It will also be listed on the Final HUD (the closing statement a homeowner receives tallying all of the settlement costs on the real estate/mortgage transaction).
What I don't think Michelle ever knew is that someone lending their own money (a "bank") does not have to disclose YSP - and that is the law (or lack of one depending how you look at it).
Michelle's proposition to ban YSP altogether by congress would prohibit many borrowers who would've been able to get a mortgage or buy a home with YSP being in existence. While many loan officers abuse the concept of YSP, the borrower who only has enough money to pay closing costs from 3rd parties (no broker or lender origination/points/processing fees) wouldn't be able to get a mortgage - because no bank, credit union, or broker is going to lend hundreds of thousands of dollars, and spend 3 weeks of their time putting a loan together, for free. Since they couldn't make YSP (since it is now banned under Michelle's proposition), and the borrower can't afford to pay points/origination/processing fees, they can't get a mortgage, thus they aren't going to be buying a home.
Let me slow down here, did I just say lenders (banks) make YSP? You probably thought Michelle was saying brokers make YSP, and not lenders, but that is only the half truth. Lenders also make a form of YSP, called SRP. It stands for Service Release Premium. It's what is generated when your mortgage servicing rights are sold. I'll use an example. Say Johnny Broker finds Mrs. Not-So-Good-Credit a loan at Novelle Financial (a sub-prime wholesale lender) with sub-prime terms, Novelle Financial tells the broker he can offer/charge 7% and make no YSP, or 7.25% and make 1% in YSP (1% in YSP = 1% of the funded loan amount). Johnny Broker, depending on whether he has good intentions or not, tells Mrs. Not-So-Good-Credit her options and she accepts the loan terms. Regardless of whatever interest rate she takes, Novelle Financial is going to make a set amount of SRP when they sell the servicing rights to Countrywide, Washington Mutual, or whomever their backing investor is at that point in time - SRP usually in the 2-3% range (SRP & YSP dollar amounts are calculated the same).
A bank could employ a loan officer who has access to their own products (lending) and other banks products (brokering), but is free to offer/charge borrowers whatever interest rate and/or fees the loan officer thinks the borrowers will accept. Instead of brokering which discloses YSP on the final HUD, they use their own bank and offer the loan without any YSP disclosed - at the same rate from a brokered bank where YSP would be disclosed. They might do this because they don't do a good job explaining YSP to their clients and most become "afraid" and back out, they don't want to be bothered with the explanation to their clients, or perhaps they just flat out lie and say the only money they are making is the origination/points/processing/underwriting fees that appear in section 800 on the GFE (and HUD). But regardless of what their are reasons for doing it - it happens.
Which loan would you feel the best about?
A) 6.25% rate, $3k in total closing costs ($1k of it is origination), no YSP disclosed as it's from a lender
B) 6.25% rate, $2.5k in total closing costs (none of it is origination), 1% in YSP disclosed as it's from a broker
C) 6.25% rate, $2.5k in total closing costs (none of it is origination), 2.5% in YSP disclosed as it's from a broker
Option C? That's because YSP doesn't matter if those are your only options.
Now say along comes Option D), which is a more generous/less greedy/better-at-finding-lenders-with-lower rates broker (whatever one's spin is), and offers 6.125% making 1.875% in YSP and $2.5k in total closing costs, or say a bank came along as Option E) with the same terms as Option D)... obviously D or E would be the best option (determining factor would probably be who you get along with best, or who has the best service, an intangible like that), but not because YSP isn't being disclosed or less YSP is being made - but because it's a better overall deal in terms of rate & fees.
I do like Michelle's "at the very least" suggestion, which HUD already tried to incorporate into RESPA legislation, where the YSP is given to the homeowner and obviosly for the broker to get any of it back they'll have to explain the details of YSP. Some states, like where I live in California, require that loans done for residents or properties in their state and by originators within their state, include a disclosure on how the mortgage broker can make their compensation, however the borrower will learn that:
· The retail price a mortgage broker offers you—your interest rate, total points and fees—will include the broker’s compensation.
· In some cases, either you or the lender may pay the mortgage broker all of its compensation.
· Alternatively, both you and the lender may pay the mortgage broker a portion of its compensation. For example, in some cases, if you would rather pay a lower interest rate, you may pay higher upfront points and fees.
· Also, in some cases, if you would rather pay less upfront, you may wish to have some or all of our fees paid directly by the lender, which will result in a higher interest rate and higher monthly loan payments than you would otherwise be required to pay.
· The mortgage broker also may be paid by the lender based on (i) the value of the mortgage loan or related servicing rights in the marketplace or (ii) other services, goods or facilities performed or provided by the mortgage broker to the lender.
-Shane Milne
Contributing member of CreditBoards.com and also a Mortgage Broker & Banker
December 19, 2006 1:15 PM | Reply | Permalink