What it is:
How it works (Example):
For example, let's assume that John wishes to borrow $100,000 towards buying a house. He receives a quote for a yield-spread premium loan with a 5% interest rate and -2.125 points, meaning that he will receive a $2,125 rebate that he can apply to the loan's closing costs.
The alternative and more traditional loan structure for the same amount might be a 4% loan and one point, meaning that the loan has a lower interest rate but requires the borrower to pay a $1,000 down payment for the loan.
It is important to remember that mortgage brokers don't always notify consumers about available yield-spread premium loans. A mortgage broker could, for example, receive a quote from a wholesale lender for a loan that has a 5% interest rate and -2.125 points. On a $100,000 loan, these yield-spread premiums translate to a $2,125 credit that can be applied toward closing costs. However, in order to earn money on the transaction, the mortgage broker marks up the loan to the consumer and quote a price of, say, 5% and 0 points, thereby retaining the $2,125 for themselves as compensation for brokering the loan.
Why it Matters:
Yield-spread premium loans usually have higher interest rates. Therefore, borrowers who plan to be in their houses for only a short time period are usually the best candidates for these loans. The extra interest over a relatively short period of time tends total less than the closing costs the borrower would have had to pay otherwise.