When you are purchasing a home, especially if it is your first home, it is very easy to become swept up in the buying process. However, it is important that you understand the different aspects of the loan process and what they may mean for you as a homebuyer.
One key component to understand is that of yield spread premiums. While you may be offered a “no-cost” loan, meaning you have no origination fees due at signing, the fact is that the mortgage broker still earns compensation, often in the form of a yield spread premium. While having a yield spread premium in place often saves you money upfront, you may end up paying much more over the life of the loan.
To get a better understanding, let’s take a deeper look at yield spread premiums and what they really mean for borrowers.
- A yield spread premium is one of many fees often associated with buying a home. However, it also means the borrower is paying a higher interest rate than their par rate.
- If you purchase a “no-cost” loan, chances are your loan will contain a yield spread premium.
- When purchasing a home, it is important to analyze the numbers to determine whether you are better paying upfront costs than the amount you may end up paying with a yield spread premium in place.
- When going over mortgage paperwork, the use of a yield spread premium may not jump out at you. Ask your broker if a yield spread premium is in place or look for key terms, such as “Yield to broker” or “direct payment to a broker.”
What Are Yield Spread Premiums (YSP)?
A yield spread premium, or YSP, is the compensation that a mortgage broker receives from the lender for offering an interest rate above the loan originator’s par rate the borrower qualified for.
Yield Spread Premium vs. Discount Points
To get a better understanding, let’s first define the par rate. The par rate is the interest rate that a borrower’s chosen lender will charge for a loan at zero points or without the application of discount points and is based on factors such as credit score. Paying points up front at loan origination gives a borrower lower interest rates, which, in turn, lowers the monthly payment. These points are paid to the lender in order to drop the interest rate. In contrast, yield spread premiums are the difference between the par rate and the actual interest rate of the loan, with the difference being paid to the mortgage broker.
Yield Spread Premiums for Mortgage Brokers
When a mortgage broker helps originate a borrower’s home mortgage loan, they receive broker fees in one of two ways. The first option is through an origination fee that is paid along with additional closing costs. However, if you opt for a “no-cost” loan, meaning no upfront costs, then a mortgage broker receives compensation through a yield spread premium. This ultimately increases your interest rate for the life of your loan.
How does it work?
Essentially, a yield spread premium allows a borrower to finance the broker’s compensation through their mortgage loan. A borrower agrees to a higher interest rate to cover this compensation, and the mortgage lender pays that compensation to the broker at closing.
How is YSP calculated?
Calculating the YSP for a mortgage loan is relatively simple. The YSP is the difference between the par rate of the loan and the actual mortgage rate for the home loan. For example, if a borrower’s par rate is 3.5 and the final mortgage interest rate is 4, then the YSP is 0.5. Depending on the loan amount and the length of the mortgage, this can be a substantial amount, and it is important for borrowers to weigh their options. While it may save money to pay the origination fees, many borrowers are unable to come up with that up-front, and the use of YSP allows more borrowers the ability to purchase a home.
Benefits of Yield Spread Premiums
Choosing a mortgage with a yield spread premium can help to eliminate or reduce some of the fees required with closing costs. High closing costs are often a barrier to homeownership for many borrowers, and the use of a yield spread premium usually allows them to obtain their home.
If a borrower plans to hold a mortgage for a short time, then opting for a yield spread premium can often save them money. Instead of paying large upfront fees, a borrower can choose the YSP and, because they are only holding the mortgage for a short time, the overall costs will be less.
Are there risks?
The main risk with a YSP is the fact that a borrower is likely to spend more over the life of the loan due to the higher rates. If a borrower plans on living in the home long-term and following the term of the mortgage, then they can expect to pay a considerable amount more. However, this is often the only option for homebuyers unable to come up with a downpayment and additional closing costs, including the origination fee.
Is a YSP right for you
A mortgage loan with a yield spread premium can be beneficial for borrowers who may not have the up-front funds to pay a downpayment and loan origination fees, thus enabling them to purchase a home they may not otherwise be able to at the time. However, in terms of cost, this can be a costly option over the course of the mortgage.
In general, the use of a yield spread premium provides the most benefits to those intending on living in the home for a short period of time, are planning to refinance down the road, or have substantial money coming in, such as an inheritance, and can pay off the mortgage before the full term. In these cases, a yield spread premium can provide significant savings.
Helping borrowers navigate the home buying process
At Hero Home Programs, we understand that buying a home can be an overwhelming and confusing process for many borrowers. We work with borrowers to find the best loan options available and ensure they are getting the best terms possible. If you are looking to buy a home and are wondering if a yield spread premium is your best option, our team can help you navigate the process and find which terms will work best for your situation.
To learn more, book a consultation with our team today.