Yield spread premium

A yield spread premium (YSP) is the money or rebate paid to a mortgage broker for giving a borrower a higher interest rate on a loan in exchange for lower up front costs, generally paid in origination fees, broker fees or discount points. This “may [be used to] wipe out or offset other loan costs, like Loan Level Pricing Adjustments (instituted by FNMA).”

The YSP is derived through the realization of a market 'price' for a loan that is above 100%. For example, a $300,000 loan with a price when sold of 101.00% would 'yield' a 1% rebate to the originator. It is important to understand that the term 'originator' refers to either a retail bank or mortgage broker. The characteristics of a loan contribute to the price offered, such as the interest rate attached, the credit score of the borrower, purchase money versus a cash-out refinance, or a streamline refinance (which lowers the price because it is typically not accompanied by a property appraisal). Higher credit scores may add 0.25% to the price, while a lower one may cost up to 3.00% - which requires the borrower to either pay a discount fee to cover the loss to the lender when the mortgage is sold, or increasing the interest rate to absorb the risk for the mortgage security investor.

Update 11/25/2008 - Yield Spread Premiums are most commonly used by the Government Sponsored Enterprises (Fannie Mae and Freddie Mac) as well as the FHA and VA loan programs to 'steer' borrowers into specific tranches of interest rate most advantageous to the marketplace through specific cash incentives to the mortgage originator. A new phenomenon has developed since the mortgage crisis of 2008 in which more compensation is paid to the mortgage brokers for 'targeted' interest rates. For example, the Yield Spread Premium on a 30-year fixed rate of 5.50% might be 1.7%, while the YSP for 5.625% on the same loan may be 0.625%, and 5.25% might cost the borrower 1%. There is no longer necessarily a direct 'linkage' between yield spread premium and interest rate offered to the borrower when obtaining conforming loan products and government program loans.

The argument can also be made that yield spread premiums are used as an incentive to originate specific programs over others that are usually less desirable for the borrower. For example, a 30-year fixed rate mortgage generally pays a much higher yield spread premium to the broker than an adjustable rate mortgage.

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