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Author: CCinOC Big funky green star, 20000 posts Top Recommended Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 127802  
Subject: Re: Definition of a pre-payment penalty Date: 12/10/2013 12:27 AM
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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.

During the refinancing boom in 1998-2005, rogue mortgage brokers used the YSP to defraud wholesale lenders by colluding with borrowers as follows. A borrower would accept a much higher interest rate that would result in a huge YSP paid to the broker. For instance, for the $800,000 loan discussed above, a YSP of 3 points would result in a $24,000 cash payment to the broker. The broker would share the YSP with the borrower. Shortly after closing the loan, the borrower would refinance the loan at a lower interest rate, essentially avoiding paying back the YSP received in a higher interest rate over time. This practice, also known as "churning," if used intentionally, defrauds the investors who paid the YSP in expectation of receiving higher interest payments while the loan is being paid back.

Wholesale lenders have introduced practices to combat this type of fraud. Most wholesale mortgage broker agreements specifically require that borrowers make at least 4 payments on their new loan, or the broker receives an Early-Pay-Off notice (EPO). An EPO requires the broker (subject to their wholesale brokerage agreement with the lender) to pay back the entire rebate they earned. It is the case that many brokers will refinance the same clients over and over again, typically in 6 month increments, and they will share the YSP with the borrower, while the borrower agrees to a higher rate on what amounts to a permanent basis, since they keep refinancing the same type of loan the same way. However, with the current softening of housing values (as of April 2007) much of that type of refinancing has come to an end. Another measure is that most lenders (and many states) have limits on the amount of YSP they will pay out (currently most lenders limit this is no more than 3 points). Lastly, brokers who repeatedly refinance borrowers in this way will almost certainly be cut off from doing business with lenders who they had been approved with.

http://en.wikipedia.org/wiki/Yield_spread_premium#No_Closing...
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