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Finance

What is a Yield Spread Premium?

By Bradley James
Updated Feb 20, 2024
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Mortgages are a special kind of loan made specifically to purchase a house or real estate. Lenders use the property as collateral against the loan. In return, the lender can loan out more money to the borrower at a lower rate of interest. Mortgage brokers make money from selling mortgage loans to potential home buyers. The mortgage broker's profit is referred to as the origination fee or the yield spread premium.

The idea or concept behind the yield spread premium is to motivate mortgage brokers to sell loans. Government Sponsored Entities (GSEs), including Fannie Mae and Freddie Mac, commonly use yield spread premiums to incentive mortgage brokers to sell a particular loan type. The mortgage broker, in return, pushes a certain loan type to the borrower. For example, a loan that is $100,000 U.S. Dollars (USD) with a price of 101.00% yield has a built in rebate to the originator of the loan worth 1 percent of the value of the loan; the originator is the mortgage broker or the retail bank providing the loan.

For example, GSEs may want to steer borrowers into a certain interest rate class. In order to incentive mortgage brokers to promote this class the GSEs will increase the yield spread premium for interest rate they are targeting. For instance, a 5.00% loan may have a yield spread premium of 1%. However, a 5.50% loan will have a yield spread premium of 1.24% and a 6.10% loan may have a yield spread premium of .95%. There isn't always a clear link between the yield spread premium and the interest rate that the borrower pays.

Yield spread premiums are also used as a way to incentive mortgage brokers or retail banks to originate more loans for particular loan programs. For instance, longer term mortgages with fixed rates often pay a much higher yield spread premium to the broker than a mortgage with a shorter term or an adjustable rate. The link depends on the loan program the GSE is promoting.

Yield spread premiums, used as a tool to incentive mortgage brokers, are not inherently bad. The concern among regulators is that lenders and brokers may not be disclosing the dollar amount of the premium on a fair and consistent basis. Due to laws in the U.S, mortgage brokers are required to disclose the yield spread premium on the truth in lending document which must be initialed by the borrower prior to starting loan paperwork.

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