Does a Broker Doing an FHA Loan Have to Disclose the Yield Spread?
There has been ample debate over the legality of yield spread premiums, which finally came to a conclusion in April of 2011. However, prior to this conclusion, Congress and the Department of Housing and Urban Development provided disclosure requirements for lenders and mortgage brokers. These requirements did not exclude loans guaranteed by the Federal Housing Authority (FHA).
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Yield Spread Premium
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To reduce the upfront costs of obtaining a mortgage, but still enable the lender to approve the loan, a mortgage broker will sometimes work out a deal with the lender. Rather than having the borrower pay the broker an origination fee upon signing the mortgage contract, he will have the lender charge an interest rate that is slightly above market rates. For example, if market rates are 5.25 percent, the lender will supply this information to the mortgage broker. However, the mortgage broker may inform the borrower that the interest rate is 5.5 percent, thus marking up the cost of borrowing. The lender then pays the broker the difference in interest, or the yield spread premium of .25 percent. (He is actually making money with both fists, that's partially why the legality has been in question. Often a broker will do this to avoid charging the borrower high fees upfront, so he is better able to hide the costs. But, the lender also pays him a fee for using their services, as opposed to someone else's, and then he also gets the benefit of receiving at least part of the yield spread premium.)
FHA Allowable Closing Costs and the Yield Spread Premium
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The FHA only permits the borrower to cover particular closing costs, which they specifically outline. Generally, the seller must cover all other closing costs. The borrower must cover any origination fees that the lender charges and document preparation fees that the broker charges. However, if the mortgage broker does not feel this is sufficient, he may employ the use of a yield spread premium. As this is actually part of the mortgage, the FHA does not disallow its use.
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Disclosure Requirements
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The Truth in Lending Act and the Real Estate Settlement Procedures Act require that the mortgage broker disclose the yield spread premium to the borrower shortly after the borrower supplies him with her initial application. The broker should present this information in the good faith estimate of closing costs. However, it is the responsibility of the lender to carefully review the disclosure and ask about a yield spread premium.
Recent Changes
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As of April 1, 2011, the Federal Reserve placed into effect new Loan Origination and Steering rules that make yield spread premiums illegal. Mortgage brokers must now charge fees upfront and base the amount on the original interest rates, as supplied by lenders. This should halt such practices by brokers and aid borrowers in reducing the costs associated with buying a home.
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References
- Harvard; Kickbacks or Compensation; The Case of Yield Spread Premiums; H. Jackson and J. Berry
- Federal Housing Authority: FHA Requirements: Closing Costs
- Berkeley Law, University of California: Yield-Spread Premiums Prohibited Under New Loan Origination Compensation and Steering Rules
- U.S. Department of Housing and Urban Development: Mortgagee Letter 2001-26
