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What is a Yield Spread Premium for a Mortgage?

What is a Yield Spread Premium for a Mortgage?

    Definition

    A yield spread premium is the difference between the interest rate you pay on your mortgage and the interest rate required by the funding lender or government sponsored enterprise (GSE), company or investor that purchases the mortgage.

    How Does a Yield Spread Premium Work?

    A yield spread premium is a relatively complicated concept so the best way to understand it is to think about the difference in the wholesale and retail price for a product. For example, if you purchase a television at a retailer you pay the retail price for the television. The retailer pays the television manufacturer a wholesale price, which is lower than the retail price it charges you. The “spread” or difference between the wholesale price the retailer pays and the price you pay is the profit that the retailer keeps when you buy the television.

    The same general concept applies to mortgages and in this case the spread between the wholesale mortgage rate and the retail rate you pay is called the yield spread premium.

    Yield Spread Premium for a Mortgage Broker

    A yield spread premium is most commonly associated with mortgage brokers which provide a good example of how a yield spread premium works. A mortgage broker does not directly fund your mortgage but instead comparison shops multiple funding lenders to find borrowers the mortgage with the best terms. The funding lenders, also known as wholesale lenders, quote the interest rate they require on a loan, which is also referred to as the wholesale rate. Mortgage brokers have discretion to charge you an interest rate that is higher or lower than the wholesale rate charged by the funding lender so they effectively serve as a mortgage retailer.

    If the mortgage broker charges an interest rate that is higher than the wholesale rate required by the funding lender, this is called a yield spread premium. In this scenario the mortgage broker receives a fee or commission from the wholesale lender for delivering a mortgage with an interest rate that is higher than the wholesale rate. So instead the borrower paying an origination fee, the borrower pays the higher retail mortgage rate and the mortgage broker is compensated by the commission received from the wholesale lender. The higher the interest rate, the higher the yield spread premium, the higher the commission the funding lender pays to the mortgage broker.  In reality, however, the borrower pays the commission indirectly by paying a higher mortgage rate.

    The mortgage broker also has the option to charge you an origination fee instead of charging a higher rate. In this case the borrower pays an origination fee directly to the mortgage broker and the mortgage broker receives no commission from the wholesale lender because they charged the borrower the wholesale rate. If you want a mortgage rate that is lower than the wholesale rate charged by the funding lender then you can pay discount points, which are extra fees borrowers have the option to pay to lower their mortgage rate.

    In short, the yield spread premium is the difference between the wholesale interest rate and the retail interest rate you actually pay on your mortgage.  The higher your interest rate, the less closing costs you should pay on your mortgage and in some cases you may receive a rebate to pay for closing costs. For example, a “no cost” mortgage charges a higher interest rate than a mortgage with standard closing costs and fees. And vice versa, the lower the interest rate, the higher the closing costs you should pay on your mortgage.

    Example

    The example below compares the interest rates and fees for a $200,000 mortgage with a 4.000% wholesale interest rate and a .750% yield spread premium to a mortgage with no premium. The mortgage with the .750% premium requires the borrower to pay no lender origination fee but a higher interest rate (4.750%) while the mortgage with no premium requires the borrower to pay a 1% origination fee, or $2,000, but the borrower pays a lower interest rate (4.000%). This represents only one example but allows you to understand how the yield spread premium impacts your mortgage rate and lender costs.

    • Mortgage 1: $200,000 Loan with .750% Yield Spread Premium
      • Wholesale Interest Rate: 4.000%
      • Premium (%): .750%
      • Interest Rate Paid by Borrower: 4.750%
      • Lender Origination Fee (%): 0% 
      • Lender Origination Fee ($): $0
    • Mortgage 2: $200,000 Loan with No Yield Spread Premium
      • Wholesale Interest Rate: 4.000%
      • Premium (%): 0%
      • Interest Rate Paid by Borrower: 4.000%
      • Lender Origination Fee (%): 1% of Loan Amount
      • Lender Origination Fee ($): $2,000

    Yield Spread Premium for Other Types of Lenders

    Although mortgage brokers provide the most clear example of how a yield spread premium works, they effectively apply to all mortgages from all types of lenders. Most mortgage originators such as banks, mortgage banks and credit unions sell the loans they originate to other companies, investors or government sponsored entities (GSEs) such as Fannie Mae or Freddie Mac. Mortgage originators sell loans because it enables them to turn around and offer more mortgages and make more money from fees. When a bank sells a mortgage, the party buying the mortgage requires a certain interest rate on the loan. The mortgage originator usually charges an interest rate that is higher than interest rate required by the party that buys the loan. So even though the bank, mortgage bank or credit union funds your mortgage directly (unlike a mortgage broker) the concept of the yield spread premium applies. The mortgage originator profits from the spread between the retail interest rate they charge borrowers and the interest rate required by the party the buys the loan.

    After the Mortgage Crisis

    In the past, mortgage brokers were required to disclose the yield spread premium they received on mortgage disclosure documents whereas funding lenders were not required to disclose their premium. Revised mortgage disclosure laws enacted as a result of the mortgage market crisis, called TRID, no longer require mortgage brokers to disclose their premium, placing them on equal ground with other mortgage originators.

    Some industry analysts claim that the new laws “eliminated” the yield spread premium in response to abuses by certain lenders who charged both a high yield spread premium (mortgage rate) and high origination fees. In reality, although the premium is no longer disclosed on mortgage disclosure documents it remains a key factor in determining your interest rate and closing costs. Brokers and other lenders have significant discretion over the mortgage rates and fees they charge borrowers as compared to the wholesale rate or rate required by investors that buy mortgages. The new laws, however, prohibit lenders from charging borrowers both a yield spread premium and an origination fee on the same loan.

    What Borrowers Should Know

    For all the complexity, confusion and attention that surrounds the yield spread premium it is not a figure that borrowers should focus on directly when they shop for mortgage. In fact, most lenders do not disclose their premium to borrowers. From a practical standpoint, the actual premium really does not matter because it is already built into the mortgage rate and closing cost quoted by lenders. Understanding how the premium works may allow borrowers to negotiate better mortgage terms but ultimately you compare rates and fees to select a mortgage. That is why we recommend that borrowers compare at least five lenders when shopping for a mortgage.

    The table below shows mortgage rates and fees for leading lenders in your area. Contact multiple lenders to request loan terms. Comparing multiple lenders and proposals is the best way to save money on your mortgage.

  • Rate Details*
    Loan Program:  
    Monthly Payment:  
    APR:  
    Rate:  
    Points  More Info:
    Points: Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
     
    Total Lender Fees:  
    Loan type:  
    Property Value:  
    Loan to Value:  
    Credit Rating:  
    Date Submitted:  
    Monthly Housing Payments
    P & I More Info
    Principal & Interest: A periodic payment, usually paid monthly, that includes the interest charges for the period plus an amount applied to the reduction of the principal balance.
    Mortgage Insurance More Info
    Mortgage Insurance: The monthly cost for a policy that protects the lender in case you’re unable to repay the full amount of the loan. It is typically required for loans that have a loan-to-value ratio between 80% to 100%.
    (Estimated)
    Property Tax More Info
    Property Tax: (Also called "Real Estate Tax.") Property taxes are government assessments on real estate property. With mortgage financing, the local, county or state tax assessment on real estate property is considered part of the monthly housing obligation and typically collected and set aside by the lender ...
    (Estimated)
    Homeowner Insurance More Info
    Homeowner Insurance: or also commonly called hazard insurance, is the type of property insurance that covers private homes. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one’s home, its contents, loss of its use, or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home or at the hands of the homeowner within the policy territory.lender ...
    (Estimated)
    Homeowner Association Fee More Info
    Homeowner Association fee: (HOA) fees are funds that are collected from homeowners in a condominium complex to obtain the income needed to pay (typically) for master insurance, exterior and interior (as appropriate) maintenance, landscaping, water, sewer, and garbage costs.
    (If Any)
    Total Monthly Housing Payments
    Lender Fees
    Points More Info
    Points Fees you are willing to pay in order to get a lower interest rate. The number of points refers to the percentage of the loan amount that you would pay. For example, "2 points" means a charge of 2% of the loan amount.
    Origination Fee More Info
    Origination Charge: A loan origination charge is a fee charged by the lender for evaluating, processing, and closing the loan.
    Credit Report Fee More Info
    Credit Report Fee: Fee charged to obtain an applicant’s credit history prepared by one or all of the three major credit bureaus. Used by lender to determine the borrower’s creditworthiness.
    Tax Service Fee More Info
    Tax Service Fee: A fee charged by the lender to cover the cost of retaining a tax service agency. These agencies monitor the property tax payments on the property and report the results to the lender.
    Processing Fee More Info
    Processing Fee: A processing fee is a charge by the lender for clerical items associated with the loan. Examples of processing include loan set up, organization of loan conditions for underwriting, and preparing required disclosures for the borrower.
    Underwriting Fee More Info
    Underwriting Fee: A fee charged by the lender to verify information on the loan application, authenticate the property’s value, and perform a risk analysis on the overall loan package.
    Wire Transfer Fee More Info
    Wire Transfer Fee: In most cases lenders wire funds to escrow companies to fund a loan. Commercial banks that perform this function will charge the lender so the fee is generally passed on to the borrower.
    (If Any)
    FHA Upfront Premium More Info
    FHA Upfront Premium: A fee paid in cash at the close of escrow or more commonly it is financed into the loan. These premiums are pooled together by the FHA and are used to insure the risk of borrower default on FHA loans. FHA upfront premiums are prorated over a five year period, meaning should the homeowner refinance or sell during the first five years of the loan, they are entitled to a partial refund of the FHA upfront premium paid at loan inception.
    (If any)
    VA funding Fee (If any)
    Flood Fee
    Other Fees More Info

    Other fees could be either additional Administrative Fees that a lender charges or it could be a Flat Fee to cover all lender charges such as: (Origination Fees, Points, Underwriting and Processing Fees, Credit Reports and Tax Service Fees)

    The flat fee does not include prepaid items and third party costs such as appraisal fees, recording fees, prepaid interest, property & transfer taxes, homeowners insurance, borrower’s attorney’s fees, private mortgage insurance premiums (if applicable), survey costs, title insurance and related services.

    Total Lender Fees
    *Actual rates and other information may vary. Sponsored results shown only include participating lenders. The information you enter on this page will only be shared with lenders you choose to contact, either by calling the phone number or requesting a quote.
    Current Mortgage Rates as of December 11, 2018
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. The actual payment obligation will be greater if taxes and insurance are included. Click here for more information on rates and product details.
  • Sources

    Mortgage Yield Spread Premium: https://www.federalreserve.gov/newsevents/pressreleases/bcreg20100816d.htm

About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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