David Saks: Factors That Influence the Way a Lender Sets Interest Rates

David Saks - Real Estate Broker - The Real Estate Mart of Tennessee, Inc. - 4040 North Watkins-Suite #4 - Memphis, Tennessee 38127 - Phone (901) 357-4663

Factors That Influence the Way a Lender Sets Interest Rates

                                factors

I wanted to provide you with a list of what I believe might be some of the important factors that cause lenders to set their interest rates the way that they do. I discussed these factors with clients, customers and colleagues in days gone by. Feel free to add anything to the list that you believe should be included.

1. Market Rates.

2. Local competition.

3. Competition within your region.

4. The feelings lenders have about the direction that the rates are going to  move.

5. The amount of insurance they have to cover their losses.

6. Whether or not they need the business.

7. If they're making money.

8. If they're losing money

9. If they like your hair.

10. How lucky they think thay can get with the rate.

Don't take all of the above too seriously. I know that denying a loan based on the appearance of hair is illegal. Have you heard similar ridiculous reasons for denying a loan?

What do you think affects the lenders rate ?

 




David Saks



Time&Temp Memphis

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Comment balloon 12 commentsDavid Saks • May 25 2008 07:56PM

Comments

Great list David, I also fear there is something in the economy that holds rates still.  Stagflation.  The decision makers feel they are damned if they do, and dammed if they don't lend!

Posted by Jim Crawford, Jim Crawford Atlanta Best Listing Agents & REALTOR (Maximum One Executive REALTORS®) over 11 years ago

You nailed that one, Jim. Hope your having a great weekend.

Posted by David Saks ((retired)) over 11 years ago

David,  Great point about local competition.  In Clarksville rates are very competitive I have far less room to negotiate YSP here than I did in Nashville.  It is great for my clients wanting to lock right away.    

Posted by Jimmy McCall, The Ex-Mortgage Consultant (JimmyMcCall.com) over 11 years ago

If they aren't making money

If they're the only game in town

Posted by Joan Mirantz, Realtor, GRI, CBR, SRES - Concord New Hampshire (Homequest Real Estate) over 11 years ago

Thanks, Jimmy. I know the YSP is a bone of contention with so many lenders, MBA included. I'd be very interested to see how HR-3915 plays out. Lending guidelines have to return to a sustainable and predictable level of risk assessment. Hope you have a great holiday, and many thanks for taking the time to visit. Hope to hear from you again.

Posted by David Saks ((retired)) over 11 years ago

LOL, Joan. Hope you have a great holiday weekend.

Posted by David Saks ((retired)) over 11 years ago

David,

It's not clear from your post whether you are speaking of lenders as I, a mortgage broker, would understand the term (the lenders that I sell the loan to) or a lender as being me, the mortgage broker.

I will tell you how I set the rate, and how I train my LO's to price.

We select our lender based on product, underwriting, service and pricing. Which of the criteria has priority depends on the customer need, which can vary.

Once the lender is selected, we price the loan on based on loan size and difficulty.

We have a pricing policy setting fee guidelines.

The state auditors spent last week in my office. they are looking for fraud and pricing discrimination.

It has been long written into the TN codes that YSP is only to lower the borrower's up front cost. It is now being more strictly enforced with the auditors.

If anybody is pricing a loan on the basis of the how they like the hair or any other potentially discriminatory factor, and that person is in Tennessee, they might be in trouble.

Richard

Posted by Richard Byron Smith, NMLS #184479, Mortgage Loan Officer (Mortgage Loan Officer, Fairway Independent Mortgage Corporation NMLS #2289) over 11 years ago

YSP is an important subject these days, Richard.

Is Yield spread premium (YSP) "extra" profit slipped into just about every loan (computed as a percentage of the loan amount) which is created only when the loan originator locks and closes the loan at a higher than market rate?

For example, the loan amount is $200,000. The loan officer locks and closes the loan at 6.5% interest rate. The real market rate...the truthful rate...the rate one could have...or should have had was 6.0%. The "spread" between the rates "yields" a "premium" (or should I say...the money?).

Isn't that how we get the name "Yield Spread Premium" ?

I've heard it said that the .5% rate spread on average generates 2.0% of the loan amount as the yield spread premium profit paid by the lender. That means the LO made an extra $4,000 (2% x $200,000 loan amount) on the loan in addition to any origination, processing, application, or underwriting fees they disclosed on the GFE or closing statement.

Is that the truth, Richard?

These are just things I've heard. Maybe you can enlighten my readers.

Posted by David Saks ((retired)) over 11 years ago

David,

The truth is that a reasonable rule of thumb about discounts and premiums, which are really the same thing, is that approximately each .5% fee changes the interest rate approximately .125%.

So that yes, your math is correct, but the conclusion that is draw should not be applied universally to all transactions and all circumstances.

This is a very rough rule of thumb, as the actual change changes with lenders and with the rate.

Paying a .5% discount might lower the interest rate from 6.5% to 6.375.

Increasing the rate from 6.5% to 6.625% might pay an additional .5% premium. 

Roughly. The ranges are not precise and depend on the bond markets actual performance and the lenders' actual pricing model and commitments. And each lender is different, so that one lender may be par at 6.5% and another lender might allow a .25% premium, and another lender might even charge a .125% discount - all at the same rate to the borrower.

The state's policy, which I think is based in part on a failure to understand the market component of yield spread premiums and discounts, is that premium pricing should reduce the borrower's up front cost.

A further state policy is that pricing should be justifiable in terms of work performed and in terms of the company business model and overhead costs, etc.

They do not want to see pricing based on what I can get away with for this customer, or any patterns of discrimination. I fully agree with this underlying principle, abuses are hurting families and this industry.

I do think that the state and HUD fail to understand and to allow for the market component, in which the broker/banker should be allowed to participate. 

One final note, in general most places cannot operate with a 2% fee. The average loan size of course has an impact on that, but 2% of $100,000 loan is only $2000. To maintain a business would be difficult with that level of income.

Without the premium pricing the buyer would need to pay upfront 2 to 3% fees, in addition to other closing costs. Most local practices, I think, treat it customary to pay 1% up front and the broker makes the rest needed to run a business in with the loan interest rate.

The loan officer does not make the fee, any more that the real estates makes the 6% commission.

There is a balance between profitability and reasonable charges, and taking advantage and overcharges. It is hard to legislate and to regulate. Some have jacked a rate up, and have done so on a selective basis, crossing any reasonableness meausre.

The difficulty lies in where in the line between reasonableness and unreasonableness.

Openness and a transparent objective pricing policy help establish that balance.

One other final note, a bank or broker that funds its own loan does not disclose the premium, and might even make an additional premium. This conversation only address the small originator broker, who must fully disclose all income. Regulations always find easier targets with the little guys.

Richard

Posted by Richard Byron Smith, NMLS #184479, Mortgage Loan Officer (Mortgage Loan Officer, Fairway Independent Mortgage Corporation NMLS #2289) over 11 years ago

Are we actually discussing a discount here, Richard, or addressing increasing the total interest which will award a YSP to the broker? I understand the concept of lowering the interest rate and wrote an article about it.

Here are some excerpts from the article:

It's simple ! You just pay more discount points in order to get a lower interest rate. Most lenders seem to agree that there is no absolute as to what to consider the costs to be in the final analysis. The rule of thumb is that 1 point (1 %) is equal to a one-eighth (0.125%) of a percentile drop in the rate. Checking with the different lenders is a good idea to see what the competition standards are for the moment. You might find that the costs are much less, depending on the level of competition between the lenders.

For example, a lender might lay this on your borrower:

10% with 1 + 0 (1% origination fee + 0 discount points)

9.875% with 1 + 0.25

9.750% with 1 + 1.00

9.625% with 1 + 1.75

9.500% with 1 + 2.25

The math is a collection of arbitrary numbers. If you want to break it down you'll disvover that you've got to put up 2.25 % of the loan to get a half point shaved off of the rate, which, in this case, amounts to about .22 percentage points off of the rate for each additional buy-down point your willing to pay. The cost is a bit more with each increase in the rate reduction in this example.

The advantages of the permanent buy-down are a set rate and payment for the life of the loan. Not only does the borrower get a cheaper rate, but the additional advantage of having a lower payment.

The disadvantage is the additional cost for the lower rate, and a permanent increase in the loan rate.

And the above has nothing to do with a YSP as far as the consumer is concerned.

But this isn't what I'm addresing here, Richard. My comment doesn't address interest rate buydown points of .5%. It addresses the premium paid to the loan broker for raising the rate .5% which will net the loan broker an additional fee from the lender because the loan broker got the borrower to agree to paying a rate higher than the one the borrower actually qualified for.

The .5% rate spread on average generates 2.0% of the loan amount, or any other arbitrary fiqure awarded by the lender to the originating broker, as the yield spread premium profit paid by the lender to the broker, the YSP. HR-3915 believes it's unfair.

A recent Harvard study noted that,"... the controversy over yield spread premiums concerns the manner in which mortgage brokers are compensated for their services. One traditional way brokers are compensated is through the
direct payments of various fees from their customers. For example, a mortgage broker might receive
an origination fee of one percent of the loan amount. In addition, brokers sometimes supplement
their income with various other fees, such as document preparation fees, application fees, and
processing fees. All of these fees would typically be paid directly by the borrower at or before
closing.

Yield spread premiums constitute a separate and less well known way that mortgage brokers
are compensated for their services. Yield spread premiums are paid from lending institutions to
mortgage brokers. A number of factors influence the setting of yield spread premiums, but the most
significant is the rate of interest on the borrower's loan. In the mortgage banking industry, a "par
loan" is a loan that a lending institution funds at 100 cents on the dollar. An "above par" loan is one
that bears a somewhat higher interest rate and for which lending institutions are willing to pay more
than 100 cents on the dollar, for example 102 cents. Typically, the excess over par is paid to
mortgage brokers in the form of a yield spread premium. The average amount of yield spread
premiums is typically in the range of $1000 to $2000 per loan, and, when present, is usually the
largest component of mortgage broker compensation. The more an interest rate charged on an above
par loan exceeds the rate for a comparable par loan, the greater the yield spread premium payment.

Yield spread premiums are controversial in many ways. While the existence of
these lender payments to mortgage brokers is revealed on government mandated disclosure
statements made available to borrowers at closing and sometimes earlier, the form of disclosure is
cryptic and does not reveal the relationship between the interest rate charged on the borrower's
mortgage and the magnitude of the yield spread premium. In addition to issues of fraud and ethical
concerns of such compensation arrangements, the practice raises the unresolved legal question of
whether the payments constitute a violation of section 8 of RESPA, which proscribes the payment
of kickbacks, referral fees, and unearned payments in connection with real estate settlements.
Moreover, there is substantial disagreement about the effect of market forces in this context. A
recurring claim of industry representatives is that yield spread premiums do not harm borrowers
because market forces demand that compensating reductions be made in other forms of mortgage
broker compensation, thus eliminating any additional expense to borrowers. Critics of the practice
contest this characterization and argue that yield spread premiums serve principally to enhance the
revenues of mortgage brokers and increase the cost of residential mortgage financing.
to the mortgage broker."  www.law.harvard.edu/faculty/hjackson/pdfs/january_draft.pdf

Section 8 or RESPA reads as follows:
Prohibition against kickbacks and unearned fees
(a) Business referrals
No 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.
(b) Splitting charges
No person shall give and no person shall accept any portion, split, or percentage of any
charge made or received for the rendering of a real estate settlement service in connection with a
transaction involving a federally related mortgage loan other than for services actually performed.
(c) Fees, salaries, compensation, or other payments
Nothing in this section shall be construed as prohibiting (1) the payment of a fee (A) to
attorneys at law for services actually rendered or (B) by a title company to its duly appointed agent...."


Congress has taken a similar viewpoint against the YSP and has sought it's elimination

TITLE I-MORTGAGE 7
ORIGINATION House Resolution HR-3915
Mortgage Reform and Anti-Predatory Lending Act of
2007''. states:

SEC. 103. ANTI-STEERING. 5
Section 129A of the Truth in Lending Act (as added
by section 102(a)) is amended by inserting after sub-
section (a) the following new subsection:
‘‘(b) PROHIBITION ON STEERING INCENTIVES.-
‘‘(1) IN GENERAL.-No mortgage originator
may receive from any person, and no person may
pay to any mortgage originator, directly or indi-
rectly, any incentive compensation (including yield
spread premium) that is based on, or varies with,
the terms of any residential mortgage loan.
........‘‘(ii) prohibit mortgage originators
from steering, counseling, or directing a
consumer into any residential mortgage
loan that is not in the consumer's interest.
........(B) shall require a mortgage
originator to act solely in the best interest of
the consumer, including finding the residential
mortgage loan that best meets the needs of the
borrower, and to meet any other duties incum-
bent on the mortgage originator under Federal
or State law when acting in such a capacity.

So, in effect, Title 1 will create a federal duty of care and outlaw steering. The anti-steering language will outlaw incentive compensation and YSP that varies with the terms of a loan. The section will allow indirect compensation if disclosed early in the loan process. This section also creates a minimum licensing standard for all originators and net worth or bond requirements of $100,000. Why would one broker be exempted from the provision of the bill any more than any other broker?

I know that many mortgage brokers consider HR-3915 harmful, and many vote Republican because Chris Dodd supports and leads 3915 in the Senate. Many also believe that the bill is anti capitalist and totalitarian and consider that banks are the main culprits in supporting it because the banks retail divisions would flourish without the nuisance of competition from wholesale brokerages. Some also believe that 3915 will damage the mortgage broker industry and possibly eliminate thousands of mortgage brokers, as has already occured.

Hope you have a fine weekend, Richard. Thanks for your comments.

Posted by David Saks ((retired)) over 11 years ago

HR 3915 will just require a different and more confusing presentation of yield spread premium. The existence and use of premium or discount pricing (again they are the exact same thing) will not cease.

As far as the consumer is concerned, assume the interest rate is the same from 2 different brokers and 1 bank.

One broker has negotiated to receive .5% from their investor.

One broker has negotiated to receive .25% from their investor.

The bank has negotiated to sell the loan at a premium of .75%, and does not disclose the premium because they close on their own warehouse line.

The customer pays the same closing costs with each.

This is an example of the market component to interest premium.

What is the different in your perspective, the perspective from a consumer orientation? How should that difference be regulated.

In a different comment, I would like to amplify how HUD is currently viewing such payments. I am glad that this discussion is open.

And thank you for your efforts, interest, and homework.

Richard

Posted by Richard Byron Smith, NMLS #184479, Mortgage Loan Officer (Mortgage Loan Officer, Fairway Independent Mortgage Corporation NMLS #2289) over 11 years ago

Most welcome, Richard.

Posted by David Saks ((retired)) over 11 years ago

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