Rob's Rant

The world of Finance can be a confusing and scary place.  For this reason many people avoid the topic altogether, until the time comes to make a move: at which time they are often unable or unwilling (or both) to wade through the information available to make sense of it.

Once of the most confusing and contentious terms out there is "Yield Spread Premium" (YSP).  YSP is also one of the most misunderstood terms.  There is even a current proposal at the Federal Reserve to eliminate the practice altogether.

So what is YSP and how does it affect you?

In a nutshell, YSP is how Banks are able to pay Brokers for mortgage loans. 

Here is a simplified example:

1) Let's assume the current market rate for a 30-year fixed loan is 5.5% + 1% Origination and 0% Discount.  You call Bank "A", Bank "C", and Bank "W" and they all are approximately this rate.  Then you call a Broker & s/he quotes you 5.5% + 1% Origination and 0% Discount.  (On a $100,000 loan, 1% = $1,000.)

2) You later learn that the Broker's quote of 5.5% + 1% Origination and 0% Discount includes a 1% YSP.  So to deliver the loan to one of the Banks you called, or possibly to another Bank you didn't, the Broker will be paid 1% by you (Origination), and another 1% by the Bank (YSP).  Your price, however, is the same: 5.5% + 1% Origination. 

So are you being overcharged?  Not because the Bank is paying YSP, you're not.  After all, you're getting the same price (rate and fees) as the fellow who walked into the Bank directly.  Remember, your payment, closing costs, etc. are the same.  So where does the YSP money go in his case?  The Bank just keeps it, & it goes to the Bank's bottom line.

Can borrowers be overcharged?  Yes, they can.  Understand this is a function of rate and fees, not YSP.  Borrowers can be overcharged by both Brokers and Banks (ever heard of Washington Mutual or Countrywide? they were Banks not Brokers).  This is where doing your homework and being educated comes in.

Understand what you are signing.  Ask questions.  Find someone you trust.  Get a Second Opinion on what you are considering, whether it is a Purchase or Refinance.  If you count on the fact that a company is big to protect you, remind yourself of the horror stories of the Bailout.  Investors at Merrill weren't protected, but the Executives were.  The same holds true for AIG and all the rest.

So the net effect of YSP is: more competition in the marketplace.  Brokers can compete with Banks on price, service, or a combination of the two.  Remember, more competition = lower prices.  (Remember your Monopoly game from when you were a kid?  You only can really make the BIG BUCKS when you control a market, represented in the game by a color group.)  This idea is also expressed by the Laws of Supply and Demand.

Remember it is the little guy who can protect you from the "Too Big to Fail" companies.  If they're "Too Big to Fail" what the heck do they care if you get shafted?  I live in the neighborhood in which I work.  Think I care if my neighbors hate me?  You better believe I do!  Think some suit in NYC cares if you're unhappy?  Not likely.  It is the mechanism of YSP that allows me to compete with him for your business.

With whom would you rather work?

(PS--If you would like further explanation, or would like other terms explained, please "comment" or shoot me a private email.  Thanks!)