Expert Article Library

Mortgage: An Overview (Part 4 of 5)

Mortgages - An Overview (4): Yield Spread Premiums

by Joseph Hughes

Yield Spread Premiums, or YSPs, go by several names, but the press seems to have settled on Yield Spread Premium. Every day the market determines the basic rate for mortgages, but it is possible to buy down the rate or to get a higher rate with less costs. This discussion primarily concerns 30 year fixed rate mortgages.

To get a rate lower than the basic market rate costs extra money, which is paid in the form of points attached to a loan. An interest rate is quoted with a number of points that range from zero to three or more. Most loans are quoted with zero, one, or two points. In general, the more points paid, the lower the interest rate. Points can be considered a way to pre-paying some interest. An extra one half of one percent of the loan amount will generally reduce the interest rate by about one eighth of one percent. Whether this amount is worth it depends on how long the borrower expects to be in the house, in addition to unanticipated events, such as severe illness, death, divorce, or winning the lottery. A borrower has to make the best estimate, then decide if the additional fee is worth a lower payment for the life of the loan.

The Yield Spread Premium enters the picture when the interest rate quoted is above the base rate for which the borrower is charged one point. By increasing the interest rate instead of charging the borrower additional points, the broker of loan agent gets a rebate. If the borrower agrees to an even higher interest rate, the rebate will be sufficient to pay for part or all of the closing costs, in addition to paying the originator of the loan. By accepting the higher rate, the borrower does not need to pay out of pocket for closing costs. In addition, the slightly higher payment is tax deductible. This decision is one that the borrower must make.

Congress has talked of outlawing the YSP because of a belief that it has been abused and leads to overcharging of the borrower. Yet, a Yield Spread Premium does have a role, for it gives the borrower more options and flexibility, and allows the borrower to decide how to spend his money, not on dictated terms. Those persons who want to eliminate YSPs only see abuses and don’t understand the positive role YSPs can play.

Continue to the next article in the Mortgage: An Overview series