The Anatomy of a Mortgage Rate

There is a lot of discussion about Yield Spread (YSP) or Rebate. Is it a rip-off or is it in the client's best interest? The bottom line is that it is a part of how our price sheets are constructed and how we price loans. Mortgage Brokers do it and so do banks. One is just more transparent then the other. Whether it is right or wrong depends more on the situation and the client/lender relationship.

Before we can  answer that question, I think it helpful to understand the technical aspects of a rate sheet and how a rate is calculated.

First, let's define the components of a rate.

Par - the break-even point where lender is willing to sell a loan. Expressed as "0".

Discount - The cost associated with buying an interest rate down. Usually expressed as a "-" number and is a % of the loan amount. Discount is usually paid by the borrower.

Yield Spread (YSP) or Rebate - The cost associated with buying an interest rate up. Usually expressed as a "+" number and is a % of the loan amount. YSP is paid to the mortgage broker.

Adjustments - fees that are added to or subtracted from the price or rate. These take into account different characteristics of the unique borrower or property. These are generally "risk" based.

Price - The cost associated with determining the final interest rate. This takes all adjustments into consideration and is then added or subtracted to the Discount/YSP columns in order to arrive at a final rate.

As you read on, please keep your opinions in check. This isn't an exercise to determine whether of not YSP is right or wrong. It's an exercise to show how rates are calculated. In another post, I'll elaborate on how YSP can be used for a client's best interest. But remember. There rates are wholesale. Mortgage brokers have costs associated with doing business. Some of these costs are passed through to the client via a slightly higher interest rate.

Here's an example of what a rate sheet looks like. Keep in mind that this is just one product on a very crowded rate sheet.

Base Rate Sheet

This is a 30 year Fixed Rate loan . There are 4 columns. On the far left is the Note   Rate. This is the interest rate that a borrower would pay. The next 3 columns are the number of days that a rate would be locked, or guaranteed, at. For this discussion, we're going to assume that the rate will be locked for 12 days and all pricing of the loan will use that assumption.

Base Interest Rates:

5.25% could be purchased by the borrower for 3.375 points, or 3.375% of the loan amount.

5.875% would be Par.

7.125% would provide the mortgage broker with a YSP of 3.5% of the loan amount

Adjustments

Here's a couple quick down and dirty pricing examples.

A) Mr. Smith wants to purchase a $200,000 home. He has a 700 credit score and will bring 20% down. This would result in a loan of $160,000.

In Mr. Smith's situation, there are no adjustments to the pricing of the loan, so a Par rate would be 5.875%

If he wanted to buy the rate down to 5.6255% it would cost him $2000 to do so or 1.25% of the loan amount

If the lender wanted to receive 1 point in YSP, he would charge an Interest Rate of 6.125%. This would result in a commission of $1800, or 1.125% of the loan amount.

B) Mr. Smith wants to refinance his current mortgage and pull $20,000 in cash out to pay off some debt. He still a 700 credit score and his current mortgage is $140,000. With the addition of $20,000, he's still at 80% Loan to Value.

There is a cost of .5% in order for Mr. Smith to access the cash in his home.

Par for Mr. Smith would now be 6%. This would pay .125% in YSP, but would be the closest to PAr. If Mr. Smith still wanted the 5.875% rate, there would be a cost of .625%, or $1000, in order for him to get it.

Why does it cost more?

 There is slightly more risk associated with the loan when someone pulls cash out of there property.

C ) The Jones want to purchase a home. They have 20% cash down payment and a 600 Credit score.

Due to the risk associated with their poor credit, their is a 1% cost in order to do the loan. This is added to the price to come up with a new "Par" rate of 6.125%. This would pay a YSP of .125%.

So, in each of these three situations we started with the same mortgage product and lender and a base rate of 5.875%. But the final rates varied based on risk. THe mortgage Broker basicall got paid the same.

A) - 5.875 %  - Purchase with Good Credit
B) - 6 % - Cash Out Refi with Good Credit
C) - 6.125 % - Purchase with Poor Credit

Hopefully this helps you to understand how rates are calculated. Again, this isn't looking at the ethics of YSP or Points, but how Mortgage Brokers all across the nation calculate rates.

Look for a future segment on how we structure rates in order to best serve our clients.