Yield Spread Premiums - Why They Matter

All loans are priced to consumers at a retail rate. There is always a markup. This markup goes by various names like “yield spread premium” or “negative points”. A point is one percent of the loan amount. Every player in the finance industry takes a cut. This holds true for fixed, adjustables, firsts and seconds, but the pricing gets a little more complicated with adjustables.

Most of us understand that when you are shopping at Macy’s or even Costco, the store gets your goods at a lower price than the one they charge you to buy it. Where the nature of this pricing differs is mortgages give you the ability to “buy down” your ultimate Note Rate – the rate that is printed on your Promissory Note. The rule of thumb is that for every point you are willing to pay, the Note Rate can be lowered by one quarter of one percent. The thirty year fixed mortgage rates that are published by Fannie Mae have always reflected some points paid up front, so they are actually understating consumer loan costs. When you look closer at the data , for instance, Bankrate.com's weekly national survey of large banks and thrifts conducted June 10, 2009 states “Rate: 5.95 percent (30-year fixed) Average Points: 0.42”, translate that into a zero points rate of approximately 6.1%.

Bear in mind that upfront points (or discount points) are non-refundable, and the payback period is between four and five years. Your payments are less than they would have been for the length of the loan, but for the first five years, you are still not ahead. Fortunately for the big banks, (let’s call the lender CitiChaseWellsAmerica – as they are hardly discernable from one another), almost all of their borrowers move or refinance every five to seven years. Most borrowers will refinance or move much sooner and they’re banking on that. They also know that their borrowing costs are much much lower than 6.1%. They pay depositors some interest to hold their money, or the capital markets an interbank rate to get this money for loaning out on mortgages. What is your bank paying on your deposits? Less than 1%? The London Interbank Offering rate is a little over 1% too, which gives CitiChaseWellsAmerica a 5% markup/profit margin. Wouldn’t you like to be earning 6.1% interest instead of 1%? So would many other buyers of Mortgage Backed Securities. As a matter of fact, they are willing to pay a premium to get this fine income stream.

The Yield Spread Premium on mortgages ranges between one and two “negative points”. CitiChaseWellsAmerica will sell this loan on the secondary market, and pocket the premium, which will never be disclosed to you. The rate you will pay is spelled out in the Promissory Note. The effect of your points will be spelled out in the APR, or Annual Percentage Rate, which is disclosed on the Truth in Lending, or Reg Z disclosure. Other fees and costs are disclosed in the Good Faith Estimate. However, if they pay part of that premium to a mortgage broker, the mortgage broker discloses that payment on your Good Faith Estimate, banks do not. Going directly to CitiChaseWellsAmerica will not decrease this premium. Their Secondary Marketing department will negotiate the sale of your loan at the highest premium they can get.

This is not an even playing field, and the National Association of Mortgage Brokers has been lobbying hard for the last 10 years to require banks to disclose this premium too. According to NAMB, “The mortgage brokerage industry is regulated by 10 federal laws, 5 federal enforcement agencies, and over 45 state laws or licensing boards. Additionally, brokers typically have some type of Quality Control (QC) requirements and NAMB members also adhere to a strict Code of Ethics.” Loan Agents that work for banks or other direct lenders require no licensing, nor training, and have enormous turnover. In the meantime, look long and hard at these disclosure documents, take the three day recission period, and ask all of your trusted advisors to look over those papers.