Discount Points or Discount are charged to the borrower by the lender (not the mortgage broker) in exchange for receiving a lower interest rate. A portion of your discount points charged to you maybe deducted on your taxes. For more information on deducting discount points consult your tax professional.
Yield Spread Premium is a form of compensation paid to a mortgage broker from the lender for selling a higher interest rate to a borrower. This is common “No Point” or “No Fee” loans where the broker does not charge the borrower an origination fee or processing fees.
Discount and Yield Spread Premium are very different concepts. Discount is a cost paid to buy a rate down. Yield Spread Premium is a payment from a mortgage lender to a mortgage broker. Here’s more detail:
Discount Points Discount, also known as Discount Points or Points are a closing cost paid to lower your interest rate. This is money that is paid, by you the borrower, to the mortgage lender to ‘buydown’ your interest rate. The ratio between points paid versus how much it lowers your rate depends on many secondary market factors. Generally 1 point which is equal to 1 percent of your loan amount will lower your mortgage rate between .25% and .50%. This will be a closing cost paid on your settlement statement and reflected on your Good Faith Estimate. You can pay fractional points, or multiple points, or no points at all. Depending on your plans and goals for your financing it may or may not make sense to pay points on a loan. It is important to note that Discount Points are different from an origination fee. An origination fee is not money used to buy your rate down, it is a charge for the origination of a mortgage loan. Discount points are money that is specifically used to buy down the rate on your new loan.
**Yield Spread Premium Yield Spread Premium (YSP) is a payment made from your lender to a mortgage broker. This payment can be taken by the broker as profit for writing a loan or used to lower or offset closing costs. Typically a broker will obtain their compensation on a mortgage loan through YSP when they are offering a loan without an origination fee. This is because a broker’s compensation is typically comprised of either YSP, origination fees or a combination of the two. The amount of YSP being paid on a loan varies depending on the interest rate the loan is originated at. Plainly put, a higher interest rate creates a more valuable loan. A higher rate produces more income for a bank, and is therefore more valuable, because of this a higher rate generates a higher Yield Spread Premium for the broker. Ultimately you should work with your loan officer to negotiate a deal that best suits your needs from a combination of interest rate and closing costs. YSP is required to be disclosed prior to the loan closing, as well as on your settlement statement at the time of closing.
A discount point is simply prepaid interest for the note rate. A consumer is offered a 5.00% note rate with 1 discount point on a $100,000 mortgage. After closing the 1 discount point or $1,000 paid by the borrower is delivered with the note to the note holder as prepaid interest. It is important to remember a discount point is not the same as an Origination Fee of 1 point. The Origination Fee is direct income to the Originator.
Yield Spread Premium (YSP) is the payment by the note holder to the Originator for delivery of a higher note rate. A consumer is offered a 5.500% note rate with no discount point on a $100,000 mortgage. In this example the 5.500% note rate from the note holder pays a 1 point YSP or $1,000. After closing the note holder receives only the note and pays the Originator the $1,000 YSP. Again do not confuse YSP with the Origination Fee.
In both examples we will assume the borrower is paying an Origination Fee of 1 point. Our borrower with 5.00% 1 discount point rate is paying a total of 2 points, $2,000, at closing, 1 discount and 1 Origination Fee. The borrower with the 5.500% rate is not paying discount points and the YSP of 1 point is being used to offset the Origination Fee, total points at closing zero (0).
The borrower with the 5.000% note rate has a $34 monthly lower payment than the borrower with the 5.500% note rate however they have a $2,000 higher cost at closing. If we take the payment saving of $34 monthly for the lower note rate of 5.000% it will take this borrower almost 59 months to recoup their original $2,000 paid at closing.
Discount Points are out of pocket fees charged to the borrower for the basic purpose of increasing the lenders or brokers yield on a given loan. Where as the Yield Spread Premium (YSP) is a yield built into a given interest rate that the lender or broker receives from the investor at the closing of a loan.
Typically, a slightly higher interest rate yields the lender or broker, a greater yield on the back end of the loan. A higher interest rate should cause the borrower to pay less on discount points. Therefore, a good lender or broker will use good judgment and not have the borrower pay excess discount points on the front end of the loan. So, what you have when comparing discount points and yield spread premium is an acceptable yield for the lender or broker and an acceptable cost that the borrower is willing to pay for the loan.
For example, you want to purchase a house that’s selling for $126,900 and the broker is charging you 3 discount points ($3780). Your loan amount with be $129,780($126,900 +$3780) amortized at the agreed interest rate and loan term (10, 15, 20, 30 years). Finally, if you receive 2 points YSP $2596($129,780 * .02) from the lender you have effectively made 5 points $6376($3780 + $2596) on a $129,780 loan.