YIELD SPREAD PREMIUMS


Yield spread premiums frequently appear on settlement statements in loan transactions. Little understood, and often maligned, yield spread premiums have generated much litigation. Two cases recently added to the debate about whether these premiums violate the provisions of the Real Estate Settlement Procedures Act (RESPA). This article examines the purpose of yield spread premiums and the requirements imposed by RESPA that must be satisfied to allow the payment of these premiums to the mortgage broker.


Section 8 of RESPA contains a prohibition against kickbacks and unearned fees paid by a lender to a mortgage broker stating "[n]o person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involving a federally related mortgage loan shall be referred to any person." 12 USCS § 2607. While it is clear that kickbacks and unearned fees are prohibited, it is unclear what exactly constitutes a kickback or unearned fee.


The yield spread premium is one situation in particular that has generated much controversy over whether the premium is a kickback or unearned fee. The Department of Housing and Urban Development (HUD) has issued policy statements addressing this issue stating a test to determine the validity of a yield spread premium. However, courts have been reluctant to find an example of a yield spread premium that violates the HUD test.

Yield Spread Premiums Defined


One of the primary barriers to homeownership and homeowners' ability to refinance and lower their housing costs is the up front cash needed to obtain a mortgage. The closing costs and origination fees associated with a mortgage loan are a significant component of these up front cash requirements. Borrowers may choose to pay these fees out of pocket, or to pay the origination fees, and possibly all the closing fees, by financing them; i.e., adding the amount of such fees to the principal balance of their mortgage loan. The latter approach, however, is not available to those whose loan-to-value ratio has already reached the maximum permitted by the lender. For those without the available cash, who are at the maximum loan-to-value ratio, or who simply choose to do so, there is a third option. This third option is a yield spread premium.


Yield spread premiums permit homebuyers to pay some or all of the up front settlement costs over the life of the mortgage through a higher interest rate. Because the mortgage carries a higher interest rate, the lender is able to sell it to an investor at a higher price. In turn, the lender pays the broker an amount reflective of this price difference. The payment allows the broker to recoup the up front costs incurred on the borrower's behalf in originating the loan. Payments from lenders to brokers based on the rates of borrowers' loans are characterized as "indirect" fees and are referred to as yield spread premiums.


A yield spread premium is calculated based upon the difference between the interest rate at which the broker originates the loan and the par, or market, rate offered by a lender. HUD believes, and the mortgage industry and consumers agree, that a yield spread premium can be a useful means to pay some or all of a borrower's settlement costs. In some cases, borrowers are able to obtain loans without paying any up front cash for the services required in connection with the origination of the loan. Instead, the fees for these services are financed through a higher interest rate on the loan. The yield spread premium thus can be a legitimate tool to assist the borrower. The availability of this option fosters homeownership. HUD Real Estate Settlement Procedures Act Statement of Policy 2001-1: Clarification of Statement of Policy 1999-1 Regarding Lender Payments to Mortgage Brokers, and Guidance Concerning Unearned Fees under Section 8(b), 24 CFR Part 3500, 66 FR 53052.


Of course, there is the potential for abuse, as a mortgage broker may attempt to steer borrowers into higher interest loans that will necessarily generate a higher yield spread premium to the broker.

Does a Yield Spread Premium Violate RESPA?


In determining whether a payment from a lender to a mortgage broker is permissible under Section 8 of RESPA, the first question is: Were goods or facilities actually furnished, or services actually performed for the compensation paid? The fact that goods or facilities have been actually furnished or that services have been actually performed by the mortgage broker does not by itself make the payment legal. The second question is: Were the payments reasonably related to the value of the goods or facilities that were actually furnished or services that were actually performed? 66 FR 53052. For a yield spread premium to violate Section 8 of RESPA, one of the two questions above must be answered in the negative. Several cases have analyzed whether yield spread premiums violate RESPA.


In Johnson v Matrix Financial Svcs Corp, 354 Ill App 3d 684, 820 NE2d 1094, 290 Ill Dec 27 (1st D 2004), the borrower instructed the broker to obtain a loan for $173,569 at 8.75%. If this was obtained, the borrower would pay the broker 3.5% of the loan amount. The broker obtained a loan for the borrower but at a rate higher than 8.75%. The borrower thus paid the broker only 1% of the loan amount. However, the broker also received a payment of $4,149.86 from the lender. The borrower argued that this was a yield spread premium that violated RESPA.


Applying the foregoing two-part analysis, the court made this statement:

[s]ome of the numerous services that a broker might provide to justify the payment of a YSP include (1) taking information from the borrower and filling out the mortgage application; (2) analyzing the prospective borrower's income and debt to determine the maximum mortgage the borrower can afford; (3) educating the borrower in the home buying and financing process; (4) collecting the necessary information and other related documents necessary for the application process; (5) verifying the borrower's employment; (6) orchestrating appraisals and inspections; (7) providing disclosures to the borrower (i.e., truth in lending, good-faith estimate); (8) helping the borrower clear up credit problems; (9) keeping the parties in contact and up to date on the status of the mortgage application; (10) ordering legal documents; (11) assessing whether the property was located in a flood zone; and (12) participating at the closing. While a payment to a broker who provides "nominal or duplicative work" would violate RESPA, it is not necessary, when justifying the payment of a yield spread premium, that the lender or the broker "tie the [yield spread premium] payment to specific services provided."

The court further stated there are several factors that are relevant when addressing the second question, including "(1) after "careful consideration of fees paid in relation to price structures and practices in similar transactions and in similar markets," whether the compensation paid to the broker is "commensurate with the amount normally charged for similar services, goods or facilities"; (2) the level of difficulty involved in qualifying [and processing] the applicant for particular loan programs, depending upon the applicant's credit rating, employment status, levels of debt, experience, etc.; (3) whether the mortgage broker is required "to perform various levels of services under different servicing or processing arrangements with wholesale lenders"; and (4) whether the mortgage broker's total compensation is commensurate for "loans of similar size and similar characteristics within similar geographic markets." [Citations omitted] "Comparison to prices in similar markets is generally a key factor in determining whether a mortgage broker's total compensation is reasonable."Johnson, 354 Ill App 3d at 694, 820 NE2d, at 1103, 290 Ill Dec, at 36.


Using these factors, the court held that the yield spread premium did not violate RESPA because the mortgagor did the following: (1) admitted in the complaint that the broker provided services in procuring the mortgage from the borrower, and (2) made no allegation that the total compensation received by other brokers in similar transactions is much lower than the compensation received by the broker in this case.


The above analysis has been followed by courts that have considered the validity of yield spread premiums with no court finding a violation of RESPA. See,e.g.,O'Sullivan v Countrywide Home Loans, Inc., 319 F 3d 732 (5th Cir. 2003);Glover v Standard Federal Bank, 283 F 3d 953 (8th Cir. 2002);Bjustrom v Trust One Mortgage Corp., 322 F 3d 1201 (9th Cir. 2003);Schuetz v Banc One Mortgage Corp., 292 F 3d at 1012-1014;Heimmermann v First Union Mortg. Corp., 305 F 3d 1257 (11th Cir. 2002).


Another argument has been presented to invalidate the use of yield spread premiums. InByars v SCME Mortgage Bankers, Inc., 109 Cal App 4th 1134, the mortgagor argued that the yield spread premium violated Part 203.27 of Section 24 of the Code of Federal Regulations. Part 203.27 states, in relevant part, the following:

The mortgagee may collect from the mortgagor ... a charge to compensate the mortgagee for expenses incurred in originating and closing the loan, the charge not to exceed: (i) [Twenty] dollars or one percent of the original principal amount of the mortgage. The mortgagor argued that a yield spread premium exceeding one percent of the principal amount of the mortgage is a violation of Part 203.27. Byars explained that [Part 203.27(a)(2)(i)] limits only fees "collect[ed] from the mortgagor" ... by the mortgagee. The [yield spread premiums] ... at issue here were not collected from [the lender], but were instead collected from [the mortgage broker]' The court found that a plain reading of the regulation itself means directly collected, not indirectly collected . . . to assert that all borrowers ultimately pay for the yield spread ... premiums through high interest rates is too strained a reading of "collect" to compel inclusion of such indirect payments.

ThusByarsheld that the yield spread premium did not violate Part 203.27.


While no court has expressly found a yield spread premium to violate RESPA,Novakovic v Samutin, 354 Ill App 3d 660, 820 NE2d 967, 289 Ill Dec 892 (1st D 2004),reh'g den., reversed a lower court's summary judgment that a yield spread premium did not violate RESPA. InNovakovic, the mortgage company paid a yield spread premium to the mortgage broker after the lender sold the loan on the secondary market. The borrower argued that because this payment was not disclosed, it violated Section 2607 of RESPA. The lender made two interesting arguments to defend the yield spread premium. First, it argued that the mortgage broker was in fact an employee of the lender and thus the payment was a commission to an employee and did not have to be disclosed. Secondly, the lender argued that the payment was a result of a sale on the secondary market and was therefore exempt from RESPA. The trial court granted summary judgment on all counts holding that the payment was to an employee and it was the result of a secondary market transaction.


The appellate court stated:

RESPA prohibits the giving and acceptance of any undisclosed fees or kickbacks pursuant to any referral agreements regarding real estate settlement services as well as the giving and acceptance of splits or percentages of charges for the rendering of settlement services other than for services actually performed. 12 USC § 2607(a). However, RESPA allows payments of bona fide salaries or compensation for settlement services performed 12 USC § 2607(c)(2), and Department of Housing and Urban Development regulations allow payments from lenders to their bona fide employees for generating business (24 CFR § 3500.14(g)(1)(vii)) without disclosure to the borrower. Novakovic at 973.

In this case, it was unclear whether the mortgage broker was an employee of the lender so the court reversed the summary judgment on this argument.


Addressing the second argument, the court stated:

RESPA exempts fees and charges paid in connection with secondary market transactions involving a bona fide transfer of a loan, taking into consideration the real source of funding and the real interest of the lender. 24 CFR § 3500.5(b)(7). However, "table-funded" transactions, i.e., a closing at which a loan is funded by contemporaneous advance of loan funds and an assignment of the loan to the person advancing the funds, are not secondary market transactions and are thus subject to RESPA disclosure requirements. 24 CFR § 3500.2(b).

The federal court of appeals has held that sales of mortgage loans from one lender to another are legitimate secondary market transactions, even where the sale has been prearranged, as long as the initial lender is the real source of funding and closes the loan in its own name.Chandler v Norwest Bank Minnesota, National Ass's.137 F 3d 1053, 1056 (8th Cir. 1998). In that case, the lender funded the loan from its own line of credit and closed the loan in its own name. The lender then sold the loan at a profit to another company. The court held that this was a legitimate secondary market transaction. However, the court went on to state that the payment to the mortgage broker was earned at the time of closing even if he wasn't paid until after the secondary market transaction. Thus, the court reversed the summary judgment and remanded the case for further proceedings.


Conclusion


The above cases are just a few examples of the courts' interpretations of the yield spread premium laws. None of the cited cases have held that a yield spread premium violates RESPA. However, if the two part test stated above was not satisfied then the yield spread premium could theoretically be found to violate RESPA. HUD has acknowledged this in Rules and Regulations 24 CFR Part 3500. Further, as is evident from theNovakoviccase, courts may be tightening their examination of yield spread premiums. In the regulation mentioned above, HUD also noted the importance of brokers and mortgage companies' clearly identifying yield spread premiums to the consumer. While the courts have yet to find a yield spread premium that violates the two part test, they have not addressed this disclosure issue. Therefore, an argument can be made that a yield spread premium violates HUD policy if it fails the two part test or is not disclosed.

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