One of the more puzzling aspects of the mortgage crisis is why so many were so motivated to sell mortgages to people who didn’t have a prayer of paying them back. You have to dig down pretty deep and you may have run across a story or two that raised your eyebrow but didn’t really offer an explanation.
That happened to me a couple of weekends ago while reading a story about a Pennsylvania woman who was fighting hard to hold onto her home after her adjustable rate mortgage virtually doubled and reset to 11 percent in 2007. Home rates were around five to six percent in 2007 so why would such a high rate kick in?
The answer is a peculiar thing known as the yield-spread premium (YSP).
Back when Andrew Cuomo was first tapped by Bill Clinton to run HUD, he condemned the YSP practice in 1997. By 1999 he had issued a ruling on YSPs that legalized the practice to such a point that dozens of federal class-action suits being waged against mortgage brokers employing YSPs were thrown out.
So what is a yield-spread premium?
The dirty little secret in the mortgage brokerage business back then was the broker was not working to get you the best loan – he was working to get you into a higher interest rate product. Much higher than the interest rate you should have qualified for. That difference is the yield-spread premium, a portion of which was then paid to him as a commission and financed by you in your overpriced loan.
Let’s take the Pennsylvania woman as an example. She finds a home she likes and goes to finance it with a mortgage broker. She has decent credit and legitimately earns an interest rate of 6.5 percent. But the mortgage broker suggests a deal. How about five percent now and the loan interest rate will reset later. Interest rates are low and expected to stay low so why not take the deal? But, in the fine print, the adjusted rate is pre-destined to reset at 11 percent, far and above the going rates.
She makes her $536.82 monthly payment for three years and then, she experiences sticker shock when her monthly payment resets to $966.95. Due to prepayment penalties built in to these loans, she will have to live with that for the next 27 years.
When you look at the difference in interest payments the yield spread premium is huge. Had the remainder of the loan been at the 6.5 percent she was qualified to receive, she’d pay interest charges of $112,400 for the remaining 27 years. But at 11 percent, she pays $204,760, a difference of about $92,000.
If the mortgage broker gets a third of that, he’s made a quick $30,000. At $30,000 a head, you can bet brokers were trolling homeless shelters, housing projects and fleabag motels trying to find people to sell loans to. And they did.
Cuomo had a chance to bar the practice, which would have taken Fannie Mae, Freddie Mac and FHA out of the loop, thereby killing the corrupt YSP practice. Instead Cuomo legitimized the yield-spread premium (a federal judge, “deplored Cuomo's ruling and said ‘the phrase yield spread premium’ was a way of avoiding calling a kickback a kickback”).
His action sent thousands out preying on unsuspecting people. Those same people are now among the millions and millions in foreclosure who financed a kickback that should have been illegal from the get-go.