Fee-d Me

Is your loan officer a monster?

If you are in the market to obtain financing for a new home purchase or refinance, then you should be aware of the fees associated with home financing and how they work. Most people can’t identify the fees associated with obtaining a mortgage, the inverse relationship they have with one another, or that the fees are almost always negotiable.

Pick Your Poison

Mortgage professionals are salespeople that are, most often times, paid solely on commission. Their commission comes in two forms; both of which are generated by their client’s loan. Most consumers don’t know that a home loan’s interest rate is priced just like a physical object such as a pair of jeans. There is wholesale pricing and there is retail pricing and the consumer can pick which pricing they want. Should you settle for a higher interest rate and be rewarded with lower up front lender fees (which are a part of the transactions overall closing costs)? Or, should you ask your loan officer for the lowest possible interest rate and pay higher lender fees at the closing table? Knowing what you want before shopping for a loan makes the overall process a lot easier.

Yield Spread Premium – (YSP)

Yield Spread Premium is a commission paid to a loan officer for charging a higher interest rate than “par” on a client’s mortgage. A par interest rate is the lowest interest rate a loan officer can pass onto a qualifying borrower from a particular lender without getting paid a yield spread premium. Essentially, the “par” rate is the wholesale interest rate pricing for a particular loan. Each day interest rates change; and so do the commissions paid to loan officers by banks. A loan officer’s yield spread commission does not come directly out of a borrower’s pocket; the actual mortgage lender pays the loan officer’s yield spread premium, usually between 1-3% of the total loan size, after the transaction closes. Though a client does not pay a yield spread premium directly to their loan officer, the client does pay a higher interest rate directly to their mortgage lender every month. Mortgage lenders pay loan officers a yield spread premium for this exact reason. It keeps borrowers paying more every month in the form of interest.

Origination Fee

An origination fee (sometimes called a loan discount fee) is a fee charged directly to a borrower by a loan officer and is a part of the overall closing costs associated with a particular loan. Aggressive loan officers will often times charge an excessive origination fee to a borrower of several “points”. A point is one percent of the total loan size. Borrowers who do not understand loan fees will pay a much higher interest rate than par for a loan and get charged an origination fee of several points. This is unnecessary as you’ll see in the next paragraph.

The Inverse Relationship

The origination fee is also called a “loan discount fee” because loan officers use it as a mechanism to pay themselves a commission for borrowers that want a par interest rate. Think about it: how can a loan officer make any money if the client receives a par interest rate? The loan officer can’t; therefore an origination/loan discount fee must be charged to the consumer make up for the par interest rate. To summarize: the lower the interest rate passed on to the consumer by the loan officer, the higher the origination/loan discount fee to compensate for the lower rate.

It is possible to get a lower interest rate than par on a loan. This is called a buy down. With a buy down, the client is getting an interest rate so low that the mortgage lender actually charges the loan officer for the deficiency (think of it as a negative yield spread premium). If the loan officer is “in the red” so to speak, because he or she is passing on an interest rate so low that they have to pay to do it, then the customer has to pay not only the negative part of the yield spread for the loan officer (the buy down), but they have to pay an origination/loan discount fee on top of it just so the loan officer can get something out of the deal. Buy downs are most worth it for clients who plan on staying in their homes for the duration of their loan and want the absolute lowest monthly payment possible. “Buying down” in periods of historically low interest rates is a wise idea for most borrowers. Another good reason to “buy down” an interest rate is when a consumer is refinancing and has plenty of extra equity to absorb the cost of the buy down, or when a home buyer gets the seller to pay their closing costs. In other circumstances that don’t involve generous sellers or extra equity to absorb the cost of buying an interest rate down, consumers will most often opt for more standard loan pricing. This equates to a par interest rate and a small origination/loan discount fee, or an interest rate slightly higher than par with no origination/discount fee.

Tips for the Consumer

• Let your loan officer know you understand the fees associated with your loan and that you want to see your loan pricing right from the lender’s wholesale rate sheet. This will help you settle on the best possible interest rate and origination/loan discount fee before closing.
• If you plan on staying in your home for a long time, go with a par interest rate and look into buying down even lower than par. Even though your closing costs will be higher, the money you save long term (loan interest every month) will be well worth it.
• If you have very little money, then settle for a higher interest rate and enjoy lower closing costs. You can always refinance to a lower interest rate later; especially if your home has equity in it.
• “No closing cost” loans are just creative marketing. There is really no such thing as a “no closing cost” loan. What happens in this scenario is that the loan officer is charging the consumer a higher interest rate than par and is making enough money in yield spread premium (YSP) from the bank to cover all of that consumer’s closing costs (property taxes, loan processing fees, title insurance fees etc). This attracts business for the loan officer who practices this technique mainly on deals involving loans in excess of $200,000 and several percentage points of YSP. For consumers that are scraping a down payment together and have little (if any) money for closing costs, this is an excellent option do be discussed with your loan officer. 
• Because most loan officers are paid on commission only which are generated by the borrower’s actual loan, there is an incentive to try and read a borrower’s level of financial sophistication and “double dip” by charging the highest possible interest rate for a loanand charge a hefty loan origination fee as well. It is a wise idea to let your loan officer know that you are not unsophisticated.
• Be strategic with your financing options and remember that you have options. If you are buying a house that is far below market value and you want to use your extra funds on property upgrades, then settle for a higher interest rate and lower lender fees; knowing you can always refinance later to a lower rate later on. Closing costs and lender fees are out of pocket expenses on a purchase (unless a private seller is involved who agrees to pay your closing costs), but are deducted from the remaining equity in a home in the case of a refinance. This means that refinancing won’t dent your pocketbook and will also save you thousands in the form of a lower rate.
• Don’t beat your loan officer up over fees. They have to make a living too and most loan officers work really hard. Keep the communication lines open and settle on an interest rate/loan origination fee that works for both parties.