Once upon a time I was a mortgage broker. During those years we fought hard for our clients to insure we were finding the best deal for them and earning enough revenue to pay our employees and keep an office running efficiently. Along came a travel agent turned radio talk show host(1) by the name of Clark Howard who proceeded to cast stones and still does so. Continuously bombarding mortgage brokers as useless middle persons Howard continually urges his growing listening audience to bypass the smaller more local offices and go straight to the lender, where they can be screwed and never know it. The happy ending of this story is to come yet in this article.
Currently there is legislation by Senator Barney Frank (D-MA) in which he seeks to further control the already highly regulated mortgage broker industry. Comments from other leader such as Barrack Obama (D-IL) and Hillary Clinton (D-NY) also mention, most specifically, mortgage brokers and how they have steered the country down a winding staircase into the deep recesses of financial failure. The happy ending to this story, likewise, is yet to come.
Please allow me to introduce your friend and mine, Yield Spread Premium; YSP for short. We are going to take a short journey to the soup aisle at your favorite grocer's on the way to meet Mr. YSP. Go ahead and pick up that can of store-brand chicken noodle and take it with us to the check out stand. Now go ahead and pay the clerk the one dollar and thirty six cents with tax. Let us talk about that soup you just purchased on the way to meet Mr. YSP.
Hold that can in your hand and look at it closely. You can see at least two components and feel the weight of a third component. You can see the can and the label and you believe there is soup inside matching the description on the label. Since there is a can and a label you can also see did you really just buy the soup or did you also buy the can and the label? Obviously you bought it all as one unit but how much did you pay for the can? What about the label how much of the price of the purchase accounted for the label?
The secret is you don't know and you don't care. All you really care about is that you purchased a can of soup and got it for a fair price. The components were not separately priced. Some of the components were listed on the label but they did not include the label and the can. Somewhat of a mystery the cost of the label and the can. Look, we are getting close to Mr. YSP's place.
What possible similarities could their be between a can of soup and a mortgage you are wondering. Only that they are both something you should shop for and understand. You don't care about the price of the can or the label because we are talking about items which ad pennies to the overall cost, right? I mean at the most the can and the label likely didn't add more than three or four cents to the cost. So two percent extra that you aren't told about in the price really doesn't make that much difference because you are talking about pennies.
Do you know the difference between the cost of obtaining a mortgage at a bank or direct lender and obtaining a mortgage through a mortgage broker? Do you know that mortgage brokers have access to something called "wholesale rates"? I bet you didn't know that a mortgage broker, by federal law, is the only one of those three required to tell you about every penny of profit they make on every home loan. It is true. The bank and the direct lender are not subject to the federal law requiring mortgage brokers to disclose the price of the "can" and the "label". So if mortgage brokers are required to disclose every penny they make from your transaction why aren't the banks and direct lenders? We will get to that I assure you but here we are at YSP's place.
Yield Spread Premium meet my pupil. Pupil, Yield Spread is the amount of income a mortgage broker earns from the lender when they find a wholesale mortgage that meets your needs and you accept that mortgage for a market competitive interest rate. Much like the way the car manufacturers pay the car dealer a portion of the retail price when they sell a car. Without YSP the front end fees would be higher and the loan would cost more. While we are on the subject let me remind you of the Columbia University Study which unequivocally demonstrates the cost of doing business with a mortgage broker is less than the cost of going directly to a bank or lender.(2) In fact, a talk show host named Clark Howard recently had to eat some words. Then he forgot again and is making a lot of unfounded accusations.
YSP works like this: If the borrower qualifies for a loan at six percent interest and the mortgage broker gets that same loan for five point seven five percent interest there is a little profit between the "wholesale" rate and the "retail" rate. The wholesale rate is call the "par" rate. Since there is a difference between the wholesale rate and the retail rate the lender will, after the closing, pay the broker a fee for the difference and that fee is called the Yield Spread Premium.
Since the cost of originating a loan has risen to about twenty-five-hundred dollars(3) the mortgage broker, just like the bank or lender, must make a minimum profit just to stay in business. Some costs are based on percentages and not fixed numbers so other loans may cost even more than that to originate. Originate means attract the client, take the application, make all of the necessary steps to get that loan to closing.
If that can of soup was like a mortgage from a mortgage broker you would individually pay for the carrots, the chicken, the salt, the pepper, the cooking time, the quality control costs, the water, the chicken, the celery, the can, and the label. You wouldn't pay any more for the soup but you would see the cost of each little component on you receipt. Only then your receipt would be called a Housing and Urban Development Settlement Costs document, or HUD-1. However, even though the price would be the same at a bank or direct lender, you would never know the cost of the can because the law does not require the banks and lenders to disclose that cost. Only the broker is required to disclose.
YSP is part of the earnings a mortgage broker makes. The lender still makes a lot more than the broker they just don't have to say. Lenders are paid what is called a Service Relief Premium if they sell the loan or a Servicing Premium if they keep the loan on their books. Usually SRP is anywhere from three percent to ten percent depending on the sale of the loan on the secondary market which has nothing at all to do with the borrower and happens after the closing is done.
Here is the bottom line and why you need to know about YSP but why elected officials like Dodd and Franks are way out of their league and intending to harm you more than help you by singling out mortgage brokers and eliminating this form of commission. Go to a lender directly and get a quote then go to a mortgage broker and get a quote. You will see that they are within a few dollars either way. The broker will have access to many lenders and will be able to shop several lenders and banks with one application. Yes, it has been abuse, but that was because you didn't know the trick. Now you know.
Brokers, like lenders, banks and you at your job, must get paid. Only a small percentage of brokers are abusers of the system. Any further legislation is going to limit you on your choices and deprive you of ever knowing how much anyone makes. Why else would lenders and banks be campaigning against mortgage brokers and funding campaigns for the people who support the elimination of YSP which would effectively shut down the cheaper wholesale mortgage broker industry? Because banks and lenders do not have to disclose their profit like mortgage brokers.
Yield Spread Premium is actually your best friend in the mortgage business.
(1) Clark Howard Biography - http://580wdbo.com/clarkhoward/bio.html
(2) NAMB Report on the Columbia University Study -
http://www.namb.org/Images/namb/documents/PDF/2005-Apr-07_NewStudy.pdf
(3) NAMB Update http://www.namb.org
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