What is Yield Spread Premium?

Yield Spread Premium (YSP) is a fee paid by the lender to the originator when a loan closes. There has been a lot of talk lately about this once obscure topic as regulators look for ways to reign in predatory lending. While YSP can be abused, it is not always bad and has many consumer-friendly uses.

First, it's useful to understand the way mortgages are priced at the wholesale level. There is no such thing as "the rate" on any given day. Here is a sample of an interest rate grid for a conventional 30 year fixed mortgage:

The numbers to the right of each rate represent the cost (discount points) or rebate (YSP) for that rate and lock term (15 or 30 days) expressed in points. A point is one percent of the loan amount ($1,000 on a $100,000 loan). So at it's simplest, the rate today would be 6.375% if you were to lock for 30 days. The zero in that column means that there is no cost or rebate for that rate. If you wanted to buy your rate down to 6.0%, you would have to pay an additional 1 point as a discount fee at closing. If, on the other hand, you were to lock at 6.75%, the originator would have 1.125 points rebate to play with.

Of course, nothing is ever as simple as it seems. There are nearly always pricing adjusters having to do with the particulars of each loan. Some examples of factors that can affect pricing include loan-to-value ratio, credit score, loan amount, occupancy, and many others. Those pricing adjustments are given in points as well, so one good use of YSP is to offset those adjustments. The non-owner-occupied adjustment, for example, is 1.75 points, which can be several thousand dollars on an average sized loan. Most borrowers would prefer to take the 7.125% interest rate, which pays that 1.75 point fee, rather than paying it out of pocket.

Another legitimate use can be offering a "no-fee loan." No-fee loans are not for everyone, in fact they are not for most consumers, but that's a topic for another day. A no-fee loan is where you pay a higher interest rate and that YSP, the negative numbers on the chart above, is used to pay some or all of your closing costs.

The problems arise when you pay the higher rate and don't get any benefit. In these cases it's the loan originator who pockets the money. On the chart above, for example, if you paid your 1 point origination fee and still got a 7.0% rate, that lender would gross 2.5 points total on your loan. This can create an incentive for unscrupulous loan officers to sell higher rates than the borrower qualifies for which, of course, is a real problem.

I'll leave ideas on how to solve this problem for another day. For now I think understanding what Yield Spread Premium is and how it works is enough for one post, and of course this is just a very basic outline. I welcome your comments and questions.