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Most homeowners have never heard of yield spread premium (YSP), yet it used to have a huge impact on the rate and closing costs you paid for a mortgage loan. We’ll cover what a yield spread premium is, how it works, and some applicable regulatory changes that were implemented after the 2008 financial crisis.

A yield spread premium, or YSP, is a form of compensation that a mortgage broker received from a lender in exchange for offering a mortgage applicant an interest rate higher than the par rate.

A par rate is an interest rate where there is neither cost or yield spread premium.

To see how YSP works, check out the hypothetical rate sheet below. It shows a series of interest rates from a high of 6.500% to a low of 5.875% in the left column.

In the right column, you’ll see the yield spread premium for each interest rate. For example, the 6.500% interest rate has a yield spread premium of 1.000. Notice that it’s a positive number, which means the broker would get paid 1.000% of the loan amount for the 6.500% interest rate.

For the 5.875% interest rate, you’ll notice the yield spread premium is a negative 0.500. This means there’s a cost of 0.500% of the loan amount to get the 5.875% rate.

This (along with risk-based pricing) is why mortgages often come with “points”.

The par rate is the interest rate at which there is no yield spread or cost. In this case, 6.000% interest rate with the 0.000% YSP is the “par” rate.

To see how yield spread impacts costs, let’s check out an example. Let’s assume we have a borrower named David who is taking out a \$400,000 mortgage with \$6,000 in closing costs, including brokers fees.

Let’s also assume that David plans to live in the home for just another five years. He won’t be in the loan for long, so he wants to keep his closing costs as low as possible.

Using the rate sheet above, let’s assume David chooses the 6.500% interest rate to get the maximum yield spread premium. Here’s how the yield spread would be calculated:

\$400,000 (loan amount) * 1.000 (YSP) = \$4,000 (yield spread rebate)

As you can see, the broker is getting a \$4,000 YSP rebate, which he plans to apply to David’s closing costs. Here’s how David’s net closing costs would be calculated:

\$6,000 (closing costs) – \$4,000 (YSP) = \$2,000 (net closing costs)

After applying the yield spread premium to the costs, David’s net closing costs equal \$2,000.

As you can see, YSP is a useful tool to help consumers get the maximum benefit out of a home loan. Unfortunately, YSP wasn’t always used for the benefit of consumers. Many brokers abused it for their own benefit.

There is no such thing as a zero-cost mortgage. If you pay zero closing costs, it’s because your lender is charging a slightly higher rate and paying your closing costs for you. Prior to Dodd-Frank, lenders did this using yield spread premium. These days, lenders pay costs with a lender credit.

## Current Interest Rates

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Yield spread premiums were banned by the Dodd-Frank Act – a sweeping financial services reform bill passed by Congress in the wake of the 2008 financial crisis.

Congress banned yield spread premiums because brokers were abusing them to pad their bottom lines. Many brokers were “steering” borrowers into higher mortgage rate loans to earn large yield spread premiums, then charging additional “junk” fees.

This practice was called “dual compensation” because the broker received compensation from fees paid by the mortgage borrower and yield spread paid by the wholesale lender.

Though Dodd-Frank banned yield spread premiums and dual compensation, it would take several years before the newly-created Consumer Financial Protection Bureau (CFPB) could implement the reforms. The Federal Reserve didn’t want to wait that long, so it published it’s own similar reforms in the Final Rule.

Like Dodd-Frank, the Final Rule prohibited yield spread premiums and dual payment mortgage broker compensation.

Mortgage brokers were no longer allowed to receive compensation from both the lender and the borrower. It was either one or the other.

The change effectively dismantled the old incentive structures under which mortgage brokers often negotiated a higher interest rate to earn a larger YSP payout.

Brokers could no longer vary their compensation based on interest rate or any other terms and conditions of the loan. Instead, they had to choose from fixed compensation models:

• Lender-paid compensation: The broker’s fee is paid directly by the lender rather than by the borrower. This reduces the visible out-of-pocket expenses for borrowers. However, brokers must agree to a fixed percentage of the loan amount with the lender beforehand, reducing the temptation to push for higher interest rates.
• Borrower-paid compensation: The borrower pays the broker an origination fee as part of the loan agreement. While this could increase the upfront costs to the borrower, it provides a clear, forthright transaction where borrowers understand what they are paying for.

Both models attempt to minimize conflicts of interest, but they also eliminate the option to fine tune the best balance of rate and fees.

When mortgage brokers choose lender-paid compensation, they’re paid exclusively by the lender out of the interest generated on the loan. This means the borrower will be charged a higher interest rate to cover the broker’s compensation.

When mortgage brokers choose borrower-paid compensation, they’re paid exclusively by fees charged to the borrower. This means the borrower has to pay more closing costs to get the loan.

Without YSP, lenders and brokers have to either charge a higher interest rate or higher loan costs to get paid. There’s no longer an option in the middle where it can be a little bit of both.

Yield spread premium, or YSP, was a rebate paid by a wholesale mortgage lender to a mortgage broker based on the interest rate. The higher the rate, the larger the rebate. The lower the rate, the lower the rebate. If the rate is low enough, the rebate became a cost to “buy down” the rate. YSP was a useful tool to help mortgage brokers find the best balance of rate and fees for their clients, but it was abused leading up to the 2008 financial crisis. Yield spread premiums were banned by the Dodd-Frank Act in 2010.

Yield spread premium, or YSP, was a rebate paid by a wholesale mortgage lender to a mortgage broker based on the interest rate. The higher the rate, the larger the rebate. The lower the rate, the lower the rebate. If the rate is low enough, the rebate became a cost to “buy down” the rate. Click through to this webpage for a simple example of how this works.