The yield spread premium is a payout that a lender will give to a loan officer for “selling” the loan at a higher rate than the par rate. The par rate is the rate at which no surplus is paid, nor is the rate being “bought down”. The yield spread premium is a valuable tool for loan officers, but not always the best situation for the borrower.

You may have heard of “no cost” loans meaning that all the upfront fees are covered or paid by the brokerage. The way this is done is through the yield spread premium. A practical example would be a home costing $200,000 being financed at a rate of 6%. Let’s assume the par rate the day of the “lock” is 5%. So the lender is able to make more money for the life of the loan or sell the loan to the secondary market for a higher price because the rate is higher. The lender will then reward the loan officer or brokerage with the yield spread premium (aka ysp) which may be around $2,000. My examples aren’t actual real life, but just illustrative of the principle. So, this $2,000 ysp is then used to cover the cost of originating the loan, the cost of the appraisal, and other misc. fees that go into getting a loan. Whatever is left after these fees is the commission that the loan officer will usually split with the brokerage he or she is working for.

Many potential borrowers are fine with this higher rate because they’d rather finance this $2,000 setup fee or loan origination fee into the mortgage payment, especially if they don’t have cash to cover the fees. The problem comes when loan officers take advantage of this and increase the rate by more than they realistically should in an unethical manner. The rate is disclosed on all of the closing documents as are the fees associated with the loan, but the par rate and the YSP paid to the loan officer are not disclosed in the loan documentation you’ll be signing at closing. So, if you didn’t know better, you may be paying that mortgage broker $3,000 to $5,000 or more to close your loan when an equally competent firm could have done the same loan for $800 to $1200 and reduced your rate significantly.

When companies advertise a “no cost” loan or advertise something with “no points”, you should make sure to ask them how they are making their money. It’s a fair question and it will save you from any surprises at closing. When you are set to close on a loan to buy a house, there is not much worse than being surprised and still having the pressure of closing a loan in order to meet deadlines. There are instances when you truly do “get what you pay for” with some of the higher quality loan officers who are able to get things done quickly and have enough experience to know what to ask for and not bother you with all of the details. These loan officers are usually those that have a flat fee or even a percentage or YSP, but instead of being different for ever borrower, it is equal.

A good loan officer will protect his or her reputation by being fair and treating borrowers fairly. It may be worth your while to ask around and see if our potential lender has been used by a neighbor, family, friend or coworker to get some feedback. It doesn’t hurt to do some shopping as well both online and offline.