New Fed limits on yield spread premium protects mortgage servicers from defaults: Moody's
A new restriction on originator's compensation issued by the Federal Reserve Aug. 16, meant to protect borrowers from predatory lending, will likely also help protect servicers from higher mortgage defaults, Moody's Investors Service said in its weekly credit outlook released today. The new restriction prohibits a loan originator's compensation (similar to a commission) from being based on a yield spread premium; effectively, the difference between the interest rate required by a lender and the rate the borrower actually accepts. It is essentially another another step towards borrower protection, just as Fannie Mae's prohibition on appraisal cutting became effective last week. During the housing boom, Moody's said loan originators use a technique called "steering" to drive a borrower to pick a higher, sometimes marginally higher, interest rate than the lender requires in order to drive up their yield spread premium. The bigger the spread premium, the bigger the bonus check for the originator. As of April 1, 2011, originator commission will be based on a fixed percentage with regard to the loan amount. The restriction is part of a new set of finalized rules to protect borrowers from unfair or abusive lending practices. A mortgage broker or loan officer will not be allowed to receive payments directly from a borrower while receiving compensation from a creditor, nor will they be allowed to charge both the borrower and lender an origination fee for the same loan. Moody's said that from a credit standpoint, these changes will likely lower rates and fees for borrowers, translating into lower probability of default on mortgages. "When this rule becomes effective, we expect that in competitive market segments lenders will pay the origination fees in the form of commissions rather than having them paid by borrowers in the form of points and fees," the report said. It also said that by giving the borrower more choice to choose an interest rate instead of being steered toward one, a borrower is more likely to choose a payment plan for suitable for their lifestyle, thus lowering the probability of default. Moody's is investigating and evaluating the consequences of noncompliance with the new rules, but has no definitive information yet. Write to Christine Ricciardi.