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What’s all this about YIELD SPREAD PREMIUM November 30, 2007

Posted by shaferfinancial in Uncategorized.
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One of the items that has been argued about, discussed, and complained about, when it comes to pricing mortgages is “Yield Spread Premium.”  To put it simply, loan officers can manipulate interest rates in a way that can pay them a commission, or where they have to pay the lender, or where there is no money going either way.  In the hands of an honest and experienced loan officer this is a tremendous tool.

The recent legislation coming out of congress has addressed this issue by banning it for the sub-prime loans.  Consumer advocates hate it because they think it is a hidden charge consumers do not understand.  In Florida, YSP has to be disclosed by mortgage brokers and correspondent lenders 72 hours prior to closing.  Banks have no such requirement.  I think the crutch of the problem is that most consumers don’t really understand how mortgages are priced and probably will never take the time to learn.

The reality is that by being charged a slightly higher interest rate buyers can limit their closing costs.  In fact, this is how those “no cost” loans being advertised by lenders as diverse as Countrywide and Bank of America are structured.  By giving you a higher interest rate the lender is earning a healthy commission, which they partially use to pay for your closing costs.  Now for folks with limited cash to put into a deal, this makes the deal work.  However, for most this is not the best way to structure the deal.  Usually, it takes 2-4 years in excess monthly payments for the break even point to be reached.  In  other words, if you had paid for the costs of the loan up front and gotten a lower interest rate you would be better off as long as you keep the loan long enough to recoup the costs, which is 2-4 years.

The argument over hidden costs simply doesn’t hold water, with the exception of banks.  You will never know how much profit banks make on their loans, but for the rest it has to be disclosed by law.  I know there are a small percentage of consumers that are consumed by fees, needing to feel like they got a good deal because they limited the fees they paid.  However, the important thing should be not what amount of profit someone makes, but what it costs you.  I mean do Wal-Mart shoppers really want to know how much profits are being made on their purchases or are they more concerned with how much it cost.  In the mortgage business that translates into how much wealth is created by the mortgage.  I demonstrate to my customers the differing wealth that can be produced by real estate with different mortgage programs.  Mostly, they choose to go with the program that maximizes their wealth production, given their financial circumstances.  I have had only one customer argue about my fees, after I have demonstrated how to put an extra $100,000 into their pockets.

Finally, this search for absolute disclosure is really the wrong way to go about protecting consumers.  Because the real problem is not how much profit the loan officer is making, but what advice they are giving.  Yesterday, again, I talked to someone who was placed into an option arm loan.  They had been paying the least amount they were allowed, increasing their loan with each payment.  They wanted out, but aren’t able to because their loan to value has gone up to over 95% of their home’s value and they no longer qualified for a loan of that size.  Where did they get this loan?  Countrywide. They had called their 1-800 # and refinanced based on the advertising of a 1 1/2% payment rate.  They even “shopped” over the phone making sure they got a “great rate.”  Do consumer advocates really think that disclosing YSP would have stopped them from getting the loan?  Would they be better off if they had paid more for their loan, but were in a fixed rate or a variable rate loan with a five or seven year fixed period?

I know I preach this, but it is not the amount of fees in the loan that is important, it is whether it is structured in a way that maximizes the wealth building capacity of real estate.  In order to get the best loan for your individual circumstances, you must deal with someone that knows what they are doing.  I promise you, that anyone that knows what they are doing is not sitting in some “boiler room” waiting for people to call a 1-800 number.  I also promise you that no one discounts money.  The ironic thing is that those that advertise the most usually charge you the most to cover all that advertising.

Disclosing YSP, is not a bad idea, it just won’t solve the problem of people getting into loans that aren’t right for them.  Banning YSP, won’t solve the problem of rapidly escalating payments with short term variable rates; only keep some people from purchasing homes because they don’t have enough reserves to pay closing costs and the cost of the loan.




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