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Home > Yield Spread Premium - What's That?
By Sue Woodard
President of Content and Publishing
Mortgage Success Source
...Why is it that on rate sheets these days, it's tough to get much yield spread premium (YSP) once you get over 101.00 or "par plus 1"? Good question - here's the answer.
Most of us who have been in the business for a number of years know that 15 years ago, it wasn't uncommon to see nice buy-up schedules on many products, with an increased yield spread premium being offered in return for a higher interest rate. In fact, you could even get par plus 5 or 6, with the buyup schedule giving about 50bp in return for .125% mark-up on the interest rate.
But then along came 1993. In the refinancing (and re-refinancing and re-refinancing once again) frenzy that ensued as home loan rates dropped ever lower, you can imagine how the investors felt as they watched these "par plus" loans get originated...but then paid off in relatively short order as increasingly lower rates made it attractive for the client to refinance, sometimes multiple times.
Think about it - when a lender offers a premium in return for a higher than market interest rate, it takes some time for them to make up with future interest earnings what they paid out in hard cold cash for the premium pricing when the loan closed.
By the way, an interesting historical note...it was a young Barry Habib who was one of the first to come up with the idea for a "no closing cost loan", using premium pricing to cover the costs. But more importantly, his biweekly appearances on CNBC let the entire nation know about this smart tool...and refi mania was on.
So after learning their lesson by premium priced loan payoffs during 1993...the lenders got smarter, and while they didn't eliminate pricing buyups, they began to trim it down to a max of 102 or 103.
Then along came 1998, and they got burned once again due to another refinancing craze. Even at a reduced buyup schedule, it still takes years for that higher interest rate to pay back the difference for the premium paid out in yield spread. So after getting fried again, they started hedging their bets by only giving about 25bp in return for an .125% mark up on the interest rate for pricing above 101.
But then came the big daddy refi bonanza of 2002 and 2003. And you can guess how the lenders paying out par plus premiums felt then - they had been burned quite enough. So the buyups got more expensive yet, and the maximum par premiums were reduced once again.
Fast forward to present day, as lenders start hearing chatter about rates nearing 4.5%. One look at their pipelines and portfolios show many loans at "higher rates" (even in the 5's!) in jeopardy of being paid off in the near term, therefore foregoing anticipated interest income. This is what is known as "servicing run-off."
And whether they believe the hype of rates in the low 4's or not, they already loathe paying out premiums, and are taking this opportunity to cut back on the premium schedules once again. You know how it goes: once bitten, twice bitten, thrice bitten...well, they are now understandably feeling pretty shy about offering premium pricing, given the current volatile and uncertain climate. And these days, lenders just can't afford to take the losses they might have been able to better shoulder in the past.
Will this ever change down the road? Never say never, as the day will come when lenders may dip a toe back in the pool and start offering more buyup premium as a competitive advantage...but for now, it's much more about survival and strength, so don't expect to see those juicy buyup schedules come back any time soon.
 Allstate Mortgage Company - 1260 N Dutton Avenue, Ste 274 - Santa Rosa, CA 95401 Office Phone: (707) 521-3434 ext 23 Fax: (707) 521-3448
We lend in the following states: California
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