Last week the Senate passed what’s become known as the Merkley Amendment.

The amendment, among other things, bans what are called Yield Spread Premiums, and it has the mortgage industry, at least a certain faction of it, in a tizzy.

Rules and regulations have come fast and furious recently.  One rule that has obviated my business model is that every broker has to credit yield spread premiums to the buyer.  I’ve done this for years, hence the name of my site, Yield Spread Credit.

My thinking had been that the borrower is paying for the yield spread via accepting a higher rate, and should get the benefit of the payment.  That benefit would be the means to reduce closing costs, achieve transparency in my fees, and take me out of the equation with regards to having any interest in market timing.  Here’s how that works:

• Accepting a higher rate will end up creating a premium in mortgage pricing.  Just as it does in any bond pricing scenario.  The premium is payed by the market to the bank,  who pays the broker, and in my case it went to the borrower.  The rationale is simple.  If it costs $4,500 to get a loan, and the borrower can get a yield spread of $4,500 in exchange for accepting a higher rate and a higher payment the borrower can reduce the current burden on their pocket book.  If the difference in payment between a lower rate and the premium rate is $45.00 then the borrower only starts losing if they are in the property or still have “that” loan after 100 months have passed.  Understanding this is fundamental to financial planning.  Call a mutual fund and they will ask you what your investment horizon is.  Call me and I’ll want to know how long you intend to own this property.  The yield spread in this case is nothing more than a tool for planning.
• The tool achieves transparency in pricing since I make only what I charge as an origination fee.  No other fees apply and the yield spread is not part of my income.
• Taking me out of the market equation is a benefit to me as well as the client.  Some lenders/brokers (most lenders really are brokers hiding behind a line of credit), will promise a rate to the client and play the market for their own benefit.  I find this to be very risky to me and my customer, stressful, and just foolish.  There very little to be gained and too much to lose.  Since I work for a single fee that’s fixed, I let the borrower decide if they want to wait on the market, if things get better that’s great for the borrower if it gets worse it’s bad for the borrower (and me since it tends to kill deals).  The parenthetical part leads me to encourage locking and achieving the long term goal rather than messing with the market and missing the boat.

New laws pretty much force my brethren to work as I do.  Some cheat, and they always will even inside a federally chartered institution.  If the recent experience with Wall Street is any indication, it seems to me that cheaters will be tolerated until a loss is incurred.

The new amendment, not law yet, wants to outlaw the premiums that I credit to the borrowers under the rationale that people are being steered into higher rates when they could get lower rates, ignoring that they may not actually have the funds to pay the other costs.  This is non-sense on the face of it, but there’s a much more sinister side to it.  What will become of the premium?

The fact is that premiums are paid to brokers because the banks receive them as well.  There’s no secret fund of money that produces the premium, and the bank is still passing the mortgage through to the public via fannie mae/freddie mac.

If I’m no longer allowed to receive this, or utilize it, what becomes of it?

My guess is the bank keeps it.  If brokers exist at all they’ll be able to offer only the rate the banks offer the broker.  That rate will not be priced at par it will be priced above par with the bank keeping the premium as profit.  That might eliminate brokers, which is a situation the banks won’t really mind.  This is an opportunity to grab market share at a time when  public opinion is against the industry, though the banks fully participated in all the worst aspects of the melt down.

And, the public will never have any idea that the banks are making this income at the public expense.  This appears to be a wonderful way of driving up the cost of financing and giving more power to big banking interests.  Is that a good thing?

…a key reason to borrow must surely be confidence that your future earnings will rise.

via Rates and price levels | The Economist.

Whenever I read a “blame the borrower” story in regards to the housing bubble I want to scream.  Yes, there are losers, but the lesson of home-ownership both implicit and explicit was that you stretch when you buy, you get comfortable, you reap the gains….

Everyone who owned real estate and benefited from the bubble, either by taking equity or moving up, needs to keep in mind that timing is an accident.  Many people have lost their homes for no other reason than that they had the bad luck to buy at the top of the market prior to a widespread contraction.   Bad timing doesn’t a loser any more than good timing makes a genius.  What timing defines is how randomness rules.

The winners should have the grace to recognize where their hard work and diligent attention to making payments got a big boost from an inflating bubble.