YSPs: The Mortgage Industry's Dirty Little Secret

I'm about to let you in on an explosive dirty little secret that no broker or bank wants you to know- a dirty little secret that spells the difference in whether you get a fair rate on your mortgage or not.

That dirty little secret is called the yield spread premium or YSP (for banks, it's called a service release premium or SYP).

What's a YSP? It's a broker's income for for increasing the rate on brokered loans (or, in the case of a bank, the bank's income for increasing the rate on correspondent loans). One YSP is equal to one percent of the total loan amount, just so you know.

Former Secretary of Housing and Urban Development Mel Martinez claims that it is costing American homeowners over $16billion in closing cost overcharges and unnecessary interest, and it has a lot to do with YSPs.

This reward that the loan originator gets for increasing your rate goes by many names. The most common are Yield Spread Premium (for brokers), Service Release Premium (for banks). overage, broker rebate, lender paid fees or lender paid compensation. But for the remainder of this article, let's just call it a YSP. Regardless of what it's called, not knowing about the YSP spells the difference between getting a fair rate or being bilked out of thousands of dollars over the life of the loan.

How does the YSP end up costing you thousands of dollars in overcharges? Simply put, it's got everything to do with your mortgage broker disclosing what he or she is really charging you- both upfront as part of your closing costs, and "in the back" by way of a YSP. There are some brokers who will tell clients that they only charge 1% of the total loan amount, while some say they don't charge any broker fees. That's all great in theory but in the real world, if brokers and loan officers actually did that, they'd be in the running for sainthood because, generally speaking, we're all on 100% commission and if you don't charge enough or didn't charge at all, how the hell are you going to feed your family and pay your bills?

What most brokers are NOT disclosing is the fact that they only charge 1% upfront but are taking more YSPs than they should. The mentality behind this is either "I want my clients to feel that they are getting a good rate and are not paying too much" or "What I get as a yield spread premium is paid directly to us by the lender, it doesn't come from the borrower's pocket."
My response to that is, "DUH! On a $400,000 loan amount, you just raised someone's rate from 5.875% to 6.5%, you're making them pay $208 more per month than they should, and to add insult to injury, stuck them with a three-year prepayment penalty while you scurry away with as much as 3 YSPs (which comes out to $12,000 since 1YSP equals 1% of the loan amount), in addition to the 1% ($4,000) that you charged as part of upfront closing costs. So now the borrower is left holding the proverbial bag stuffed with a three-year prepay and a fully indexed rate that is much higher than it should be, which in turn leads to higher negative amortization. DUH!"

In my case, since I dislike playing games and bargaining from the onset, my rule is always this: disclose upfront, disclose upfront, disclose upfront. "These are my fees and it's your choice whether you want to pay for all of it upfront, pay some of it upfront and have the lender pay for the rest as a yield spread premium (which typically works best for most folks since the interest rate and their upfront closing costs both stay reasonable) or pay nothing upfront in order to have the smallest amount of closing cost possible as long as one keeps in mind that this translates to a much higher interest rate."

I find that it's a great way to weed out the people I'd rather not have as clients anyway. so I'm able to work with the no-nonsense straightshooters who appreciate dealing with an upfront mortgage consultant who charges only what's fair and reasonable and won't hide YSPs from them.

I had one client who practically fainted when she received her Good Faith Estimate from me. It turned out that her last loan officer had been pulling the wool over her eyes for several years. "I only got charged a flat $800 broker feewhen I refinanced last year!" she cried. I asked her to bring her Final HUD-1 from her last mortgage transaction so we could go over it. Surprise, surprise! Her loan officer had whacked her with a 7.9% on a 30-year fixed whe her profile indicated that she would ahve been able to get a 5.5% for her $325,000 loan amount. It was a pretty rude awakening when she found out that her loan officer had made off with a 3% yield spread premium on the back. So, what she thought had been a bargain at $800 turned out to be a costly illusion. Not only did she get hit with a higher rate where she ended up paying more per month, she also ended up with a 2-year prepayment penalty as well. After I handled her transaction, she wrote me a really nice email that said, "I know I wasn't the easiest person to deal with. I was played a fool for so long that working with someone who tells it like it is was a bit of a shock, but I learned so much from you during my transaction, and I know better now."
So how do a lot of mortgage brokers explain it when their clients spot the YSP on the Good Faith Estimate or the Final HUD-1? There are two columns on a GFE and a HUD-1 - debit and credit. Since the YSP doesn't show up as something coming out of the borrower's pocket upfront, most borrowers don't even notice it. The ones that do are given some hogwash along the lines of "Oh, that's just a standard incentive that we're given by the lenders on every loan."
Now don't run off to your nearest savings and loan institution either, thinking that you won't find YSPs over there. While Federal Real Estate Procedures Act rules that govern informing you of this extra profit, this only applies to the YSP in brokered loans. Banks and broker-banks- because they have more money to pay lobbyists in Washington- are completely exempt from disclosing that "extra" profit they receive on their loans because technically, their loans are not brokered loans. Scary, no ?

Don't get me wrong. There are advantages to the YSP. If you want to shell out less in upfront costs, or if you want what is falsely termed a no-closing cost loan (I hate the term because it is so misleading. Read my lips: There is no such thing as a no-closing cost loan!), you have the option of having the lender pay some or all of your broker's fees by way of a YSP. The trick is in making sure that you know what that YSP is.

Want to see if you got ripped off or want to ensure that you don't get ripped off? If you're a homeowner, take out your loan documents and look for your Final HUD-1 (the settlement statement of closing costs) and call me so we can through it with a fine-tooth comb. If you're a homeshopper just starting the homebuying process, pull out the Good Faith Estimate that you were given and give me a holler. You've got thousands of dollars at stake. Learning to spot the YSP could save you a lot of money in the long run.