Today we received the kind of reader comment that I love to see: A smart and fearlessly stated position on an industry issue that really matters. It was written by Michael Hoskinson of Foundation Realty in Huntington Beach, Calif. (Browsing the web, I see that Hoskinson also made the point in Inman Real Estate News this week.)
Hoskinson is criticizing the yield spread premium, which is a cash payment given by a lender for higher-rate loans. The higher the rate on the loan (that is, the higher the “yield spread” over the lender’s minimum), the more the cash involved. Although in theory the cash can be used entirely to reduce the closing costs of the borrower, research shows that in practice most of it is kept by the broker. About 90% of subprime mortgages involve yield spread premiums, which can add up to thousands of dollars and constitute the biggest part of compensation that a broker gets.
Here’s an excerpt of Hoskinson’s comment to Hot Property:
"The YSP or "Yield Spread Premium" is nothing more than the Bank's kickback to the broker for doing the loan. The worse the loan, in terms of interest rate, that the broker gets the borrower to agree to, the higher the YSP dollars go to the broker. What exactly, other than honesty, is the broker's motivation for helping a borrower get the best available deal? Combine greed, low barrier to entry and minimal mandated disclosures and you have a recipe for a lending disaster at the borrower level. Until there are mandated disclosures that spell out, in 14-point type and plain language, what exactly a borrower is encumbering themselves to in total and how the broker or bank is compensated this system will continue to fail the public."
Giving yield spread premiums to brokers is one of those industry practices that has gone on for years but, on closer scrutiny, is extremely hard to justify. As Hoskinson says, it creates an obvious conflict of interest.
Click here to see what the Center for Responsible Lending said about yield spread premiums back in 2004, before the current subprime meltdown. The center wrote:
"The effect of YSPs is to steal equity from struggling families. Not all loans with YPSs are abusive, but because they are permitted and easy to hide, unscrupulous brokers can make excessive profits without adding value to borrowers."
Here's a more neutral take on yield spread premiums from Erate.
And here's a 2001 piece from Realty Times defending YSPs on grounds that most brokers turn over the payments to borrowers by applying them toward closing costs.
BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.