Yield Spread Premium
BY ALAN M. TARTER
AND CHRISTOPHER J. GULOTTA
New York Law Journal
JANUARY 19, 1999
THE MORTGAGE brokerage
industry has grown in recent years to the point where as many as
half of all home mortgages are facilitated by a mortgage broker.*1
The broker acts as intermediary between the borrower (whether a
home-buyer or a homeowner refinancing an existing mortgage) and the
institutional lender (lender).
For facilitating the
transaction,*2 the broker receives compensation from either the
borrower or the lender or both. Borrowers may pay brokers a
``direct,'' or origination fee based on ``points,'' or a fractional
percentage of the loan amount. In certain instances, however, the
broker receives an ``indirect'' fee from the lender. Fees paid by
the lender to the broker are known as yield spread premiums (YSPs).
A YSP*3 is a payment to the broker
from the lender for originating and processing a loan with with
either: (i) a rate identical to that which a borrower could
otherwise obtain from a lender (i.e., the lender's ``retail rate'')
or (ii) a fractionally higher interest rate _ an ``above-par'' loan
_ than the lender is prepared to offer borrowers. A higher YSP is
paid most commonly when the broker arranges terms somewhere in
between the retail rate available to direct borrowers and the
wholesale rate that lenders offer brokers.
In recent years, following on the
growth of the mortgage broker industry, consumers and their lawyers
have come to question the practice of banks paying brokers YSPs, and
a few courts have suggested that such payments are unlawful under
Sec.8 of the Real Estate Settlement Procedure Act (RESPA). The
Department of Housing and Urban Development (HUD), while
contemplating the regulations discussed below, has never officially
stated a view as to the legality of YSPs.*4
This article will examine (i) the
practice of paying mortgage brokers in the form of YSPs, (ii) the
issue of whether such fees may be unlawful, (iii) the pending
purported class actions filed by borrowers against mortgage brokers,
(iv) the prospect of new regulation of YSPs and (v) the manner in
which mortgage brokers can act to insulate themselves against the
threat of litigation.
Yield Spread Premiums
While, in some cases, the
mortgage broker will be compensated solely by ``direct fees'' paid
by the borrower, it often happens that the borrower either lacks
sufficient cash to pay points on the loan at closing or, for other
reasons, prefers not to pay such points. In this event, the broker
may still be able to offer a ``no-fee/no-point'' loan by looking
to the lender for compensation in the form of a YSP.
In exchange for arranging for
the borrower to accept an at-par or above-par interest rate (which
will directly effect the YSP paid to the broker), the lender
(rather than the borrower) pays the broker this "indirect''
fee. Ultimately, in the instances where the borrower has accepted
an above-par interest rate, the indirect fee*5 is paid by the
borrower in the form of fractionally higher interest payments.
While YSPs have become common in
the industry, home buyers and consumer advocates have complained
that the fee serves as an inducement to the broker to misrepresent
the lowest available mortgage rates.*6 A bank may, for example, be
willing to offer a mortgage on a particular property at 7.5
percent (i.e., its retail rate). If the broker arranges for its
client to pay the retail rate, the broker receives a YSP fron the
bank. If, however, the broker arranges for the borrower to accept
a rate above the bank's retail rate (i.e., above-par) at, for
example, 7.75 percent, then the bank will pay the broker a higher
In the instances where a broker
has arranged for an above-par loan, consumers have alleged that
they were not aware that they might have obtained a lower rate
(i.e., the at-par, retail rate). Additionally, while the higher
YSP in such instances appears to be between the bank and the
broker, it is financed indirectly by the additional interest paid
by the borrower.*7
During the past two or three
years, a number of borrowers have initiated lawsuits, often filed
as putative class actions, challenging the legitimacy of YSPs
under Sec.8 of RESPA, 12 USC Sec.2607. Culpepper v. Inland
Mortgage Corp.*8 is typical in its facts of the many YSP cases
filed around the country.
In that case, the
plaintiff-borrower retained Premiere Mortgage Company (Premiere),
a mortgage broker, which arranged for a 30-year loan from Inland
Mortgage Corp. (Inland) at an interest rate of 7.5 percent. The
borrower paid Premiere a one point ``origination fee,'' or $760.
In addition, Inland paid the broker a YSP of 1.675 points, or
The borrowers alleged that
Inland's rate sheet provided for a 30-year loan at 7.25 percent,
but that if Premiere had offered those terms, its YSP from Inland
would have been just .125 points, or $97. The court noted that the
loan in this case was ``table funded,'' meaning that Inland
advanced the funds and Premiere contemporaneously assigned the
loan to Inland.
The borrower alleged that this
YSP was in essence a kickback from the bank to the broker in
violation of RESPA Sec.8,*9 which provides:
(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 part of a real estate settlement service
involving a federally related mortgage loan shall be referred to
(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
(c) Nothing in this section
shall be construed as prohibiting . . . (2) the payment to any
person of a bona fide salary or compensation or other payment for
goods or facilities or for services actually performed.
In this case, the district court
dismissed the plaintiff's claim, but the Eleventh Circuit
reversed, holding that summary judgment was improper because
payment of the YSP might violate RESPA.
The district court had concluded
that Premiere had sold the loan to Inland and that the YSP fell
within the ``payment for goods'' (i.e., the loan) exception to
RESPA Sec.8(c). The appellate court, seizing on the fact that the
loan was table funded, held that there was no actual sale and that
the YSP was in fact a referral fee in violation of Sec.8(a). The
panel concluded, ``A referral actually occurred when Premiere
chose to register the Culpeppers' loan with Inland and not with
the other Lenders with whom Premiere did business.''*1*0 While
nothing in the law bars sales of mortgages in the secondary
market, the lender conceded that this was not a secondary market
Similarly, the Culpepper court
held that the YSP was to compensate Premiere for providing
services to Inland, as it was undisputed that the payment of the
YSP was not tied to the quantity or quality of the services that
Premiere provided. ``Rather, the sole determinant of whether a
yield spread premium would be paid was the interest rate on the
loan.'' Thus, the YSP payment was held to be simply in exchange
for a referral, which does violate the statute.*1*1
To date, the Culpepper court is
the only federal appellate court to hold that a YSP may constitute
a violation of RESPA. The district courts, for their part, are
divided on the issue.
In Mentecki v. Saxon Mortgage,
for example, an action in the Eastern District of Virginia, the
defendant-lender moved to dismiss, contending that YSPs are
authorized implicitly by HUD regulations which refer to them in
passing. The court rejected this argument and squarely held that
such payments are illegal kickbacks under RESPA:
The court concludes that the
payment of a yield spread premium is a referral prohibited by 12
U.S.C. Sec. 2607(a). By their very nature, yield spread premiums
are not compensation given for services actually performed by the
broker. The reality of the transaction is that the broker benefits
by payment of the premium, the Lender benefits by obtaining a
higher than par loan, and the borrower pays. Quite simply, the
premium regards the broker for referring the above-par loan.*1*2
The court went on to reject the
argument that a YSP is a legitimate fee ``for services actually
performed'' within the safe harbor of Sec.2607(c):
The court is unable to see what
service is provided to the consumer, as it must under section
2607(c)(1)(C) or (c)(2), unless it is the provision of a bad deal.
Nor can the premium be defended as compensating the broker where
the broker has already charged the borrower directly for all
While the court denied the
motion to dismiss, it did allow for the possibility that the
defendants would be able to prove that YSPs are authorized as fees
for services under the safe harbor of Sec.2607(c).
A few district courts, generally
prior to Culpepper, have held that payment of a YSP does not
violate RESPA, and have granted lenders' motions for summary
judgment to dismiss the action. In Barbosa v Target Mortgage
Corp.,*1*4 for example, a court in the Southern District of
Florida engaged in an extensive analysis of the law and economics
of the situation and held that YSPs are not unlawful payments
under the statute: ``From a straightforward reading of the
statute, the Court concludes that [the Lender] cannot have
violated subsection (a), because the undisputed record evidence
establishes that its payment to [the broker] was not for the
referral of business.''
This court considered the YSP to
be a different form of payment to the broker for its services, not
a ``kickback'' or a ``referral fee'' paid by the lender. The court
went on to conclude that ``under the facts of this case the yield
spread differential payment resulted from a market transaction
legitimately structured by [the Lender]. Under RESPA, this
suffices to establish reasonableness.''*1*5 It should be noted,
however, that the Barbosa court now seems to be in the minority on
this issue, and it relied in part on the district court opinion in
Culpepper, subsequently reversed on appeal.
Class Action Issues
Perhaps more important than
whether YSP payments are unlawful is the question of whether YSP
actions can be litigated as class actions. While no circuit court
has yet ruled on the question, lender and broker defendants have
fared better on this issue as the district courts have ruled
generally, if not universally, that classes of plaintiffs
comprised of mortgage borrowers challenging YSP payments should
not be certified pursuant to Rule 23(b)(3) of the Federal Rules of
In Moniz v. Crossland Mortgage
Corp.,*1*6 the plaintiff moved to certify a class of all borrowers
who obtained a loan from the defendant bank where a broker was
paid a YSP. The court denied the motion, however, holding that
class certification was not appropriate because the question of
whether a particular YSP violated RESPA depended on whether it was
``reasonable'' under the circumstances.
Because the reasonableness of
each YSP in each mortgage transaction would have to be evaluated
individually, common questions of law and fact were held not to
So long as the ultimate
combination of compensation is reasonable, the broker and borrower
are entitled to negotiate the loan that best fits the needs of the
transaction at issue. Thus, in order to resolve this dispute, this
Court would have to evaluate each of the 18,000 transactions at
issue to determine if the broker received the right amount of
compensation, whether through points from the borrower, a yield
spread premium from the Lender, or both. This analysis necessarily
would result in questions regarding individual members of the
class predominating over questions common to the class.*1*7
Similarly, in Marinaccio v.
Barnett Banks,*1*8 the court denied the plaintiff-borrower's
motion to certify a class, in large part because it concluded, on
the merits, that payments of YSPs to brokers by lenders are not
per se violations of RESPA. Moreover, in order to determine
whether a particular payment had run afoul of the statute, the
trier of fact would need to examine what services were actually
performed in exchange for each of the premiums paid in each of the
approximately 6,700 separate loan transactions to be encompassed
by the proposed class.
Because HUD regulations
implementing RESPA call for a review of whether the payment in
each of these transactions bears a ``reasonable relationship to
the market value of the . . . services provided,'' each claim
would require the analysis of such factors as geographic market
variations, the size and type of the loan and the amount of
services required for the particular transaction. Thus the court
found that questions of law or fact common to the members of the
proposed class did not predominate over the questions affecting
only individual members as required by Rule 23(b)(3).*1*9
More recently, however, two
class actions lawsuits were certified. In Mulligan v. Choice
Mortgage Corporation *2*0 a New Hampshire federal court granted
the borrower-plaintiff's motion to certify a class, rejecting the
same argument that prevailed in Marinaccio. The defendant had
argued that the trier of fact would ``not be able to determine
whether any of the loans at issue are subject to the exemption
without first making a case-by-case determination as to whether
the amount of the YSP Choice received in any particular case bore
a `reasonable relationship' to the market value of any services
Choice provided to the Lender or borrower in that case.''*2*1
Allowing the class action to go
forward, the court permitted the plaintiffs the opportunity to
prove that the defendant-lenders provided no service in return for
a YSP on a class-wide basis:
The fatal flaw in Choice's
argument is that it fails to address plaintiffs' claim that Choice
violated RESPA because it failed to provide any legitimate goods
or services in exchange for the YSPs it received. If this
assertion can be proved at trial through evidence common to the
entire class, it will not be necessary to conduct a case-by-case
inquiry of the reasonableness of any particular YSP as the trier
of fact will already have determined that Choice failed to render
any compensable goods or services in exchange for the YSPs it
The court refused, however, the
plaintiff's motion to certify a class as to its claim that the
lenders violated the Racketeer Influenced and Corrupt
Organizations Act (RICO) as well as RESPA.*2*3
Mulligan remains decidedly the
minority view. Indeed, even after the Eleventh Circuit, in
Culpepper, gave some support to the merits of RESPA claims,
district courts have continued to deny motions for class
certification. In Taylor v. Flagstar Bank, FSB,*2*4 the court
analyzed exhaustively the cases both before and after Culpepper as
well as Rule 23, and concluded that trying a RESPA case as a class
action would be inappropriate:
The court cannot decide that an
illegal kickback or fee-split occurred, without looking to see
exactly what services were performed, and whether those services
were reasonably charged. Moniz, 175 F.R.D. at 4 (``in order to
resolve this dispute, this Court would have to evaluate each of
the 18,000 transactions at issue''); Martinez, slip op. at 5
(``Although the Court's inquiry into the nature of the transaction
structure by the Lender might involve common issues, the equally
or more important issue of the services provided by the broker to
the borrower (and possibly the Lender) would differ in each
case.''). Class certification is improper, simply put, largely
because of the nature of the law at issue.*2*5
The Taylor court considered
Culpepper and concluded that it did not speak to the class
certification issue at all.
New HUD Regulations
Despite the recent spate of
litigation, HUD has not yet issued a statement as to the
lawfulness of YSPs. The agency has, however, proposed a rule
amending Regulation X (24 CFR 3500.14(g)(2)) which would establish
a presumption, referred to as a ``qualified safe harbor,'' that
YSPs are legal and permissible if the mortgage broker provides
disclosure of its role and its fees, and uses a form contract
(between broker and borrower) drafted by HUD. This contract would
disclose the mortgage broker's compensation from both sources (the
borrower and the institutional lender), and would ``clarify for
the borrower the differing functions of mortgage brokers and the
role of the mortgage broker in the particular transaction.''
The proposed HUD mortgage broker
contract would inform the borrower whether: (i) the broker is the
agent of the borrower and ``will shop for the most favorable
mortgage loan that will meet the borrower's stated objectives,''
(ii) the broker represents the lender and merely arranges loans,
or (iii) the broker is operating as an independent contractor
representing neither the lender nor the borrower.
The contract would also disclose
whether the broker is to receive an indirect fee from the lender
and/or a direct fee from the borrower. The contract would specify
the maximum points and other compensation that the broker would
earn for a loan up to a particular amount. If the mortgage broker
uses the HUD form and performs consistently with it, any YSP the
broker earns would be presumed legal.
However, even where a mortgage
broker uses the HUD form contract, the presumption of legality
would be rebuttable in cases where the compensation received by
the mortgage broker exceeded a yet-to-be-determined formula. As
this formula was conspicuously absent from the proposed rule,
mortgage brokers are still justified in their concern that HUD
will introduce regulations limiting their fees (for example, to a
one- or two-point maximum).
Even if a particular transaction
does not fall within the proposed safe harbor, however, a broker
could rebut any suggestion that a YSP is unlawful by establishing,
as under the current law, that their compensation, in the form of
a YSP or otherwise, is reasonably related to the value of the
goods and services provided under the unique circumstances
associated with each loan transaction.
In addition to HUD's new
proposal, a bill was introduced in the last Congress that would
have suspended YSP-related class actions. The Mortgage Litigation
Reform Act of 1998, introduced in the Senate by Senators Rod
Grams, R-Minn., Lauch Faircloth, R-N.C. and John Breaux, D-La. and
in the House by Representative Robert L. Ehrlich, R-Md., would
have imposed a moratorium on the certification of class actions
through the 1998 calendar year.
This legislation was not passed
before the 105th Congress went out of session. Prior to
adjourning, however, Congress sent a joint House/Senate Conference
Report to the White House which indicated that ``Congress never
intended payments by Lenders to mortgage brokers for goods or
facilities actually performed to be violations of RESPA.'' The
report further directed HUD to clarify its position regarding YSPs
within 90 days from the enactment of the HUD/VA FY 1999
appropriations bill, which occurred in late October. Thus, a new
rule must be announced by the end of January 1999.
Whether or not HUD ultimately
enacts its proposed amendment to Regulation X, mortgage brokers
would be well advised to adopt its program of full disclosure,
indicating to borrowers the possibility that the broker will
accept a YSP from the lender as part of the broker's compensation.
HUD and the courts that have been sympathetic to borrowers' RESPA
claims tend to be motivated by the same principles: that consumers
should be granted meaningful and timely disclosure of fees, direct
and indirect, to be paid to their brokers.
While HUD appears to approve of
the availability of ``no fee/no point'' loans, the agency does
seem concerned in the instances where such loans are made possible
by ``indirect'' fees that are disclosed late, if at all. There is,
after all, no reason to expect that a consumer unable or unwilling
to pay points on a loan up front, or a consumer whose unique
circumstances require an industry expert to properly place the
loan with an appropriate lender, will object to his broker being
compensated by the lender in the form of a YSP.
Nor will the borrower
necessarily object to paying for the broker's service indirectly.
The proposed rule seems motivated by the notion that the ``no
fee'' loans involving an above-par rate (and thus a higher YSP)
may not truly be free, and that consumers should not be told
otherwise. Acting in accordance with HUD's proposed disclosure
rules would go a long way toward establishing a broker's good
faith, both within this industry and with the general public.
(1) See Department of Housing
and Urban Development estimate discussed at 24 CFR Part 3500.
(2) The mortgage broker acts as
a middleman between lender and borrower. The broker processes the
mortgage application, reviews the borrower's income, asset and
credit history, and often provides property analysis. See Barbosa
v. Target Mortgage Corp., 968 FSupp. 1548, 1552 (S.D. Fla. 1997).
(3) Yield spread premiums are
also referred to as ``Servicing Release Premiums,'' ``Additional
Compensation Paid By Lender,'' ``Par Plus Premiums,'' ``Premium
Pricing'' and/or ``Volume Based Compensation.''
(4) See Barbosa v. Target
Mortgage Corp., supra, noting HUD's impasse on the issue.
(5) The terms ``direct fees''
(those paid to the mortgage broker by the borrower) and ``indirect
fees'' (fees paid by the lender and funded by a fractionally
higher interest rate) are taken from the HUD report on its
amendment to Regulation X, discussed infra.
(6) See, e.g., The New York
Times, Jan. 25, 1998, sec. 3, p.10, col 1; Aug. 31, 1998, sec. 9,
p. 3, col 1.
(7) The New York Times, Aug. 31,
1998, sec. 9, p.3, col 1.
(8) 132 F3d 692 (11th Cir.
(9) 12 USC Sec.2607.
(10) 132 F3d at 696.
(11) Id. at 697. See also
Brancheau v. Residential Mortgage and Mercantile Bank of St.
Louis, 1998 U.S. Dist. LEXIS 14439 (D. Minn. Sept 4, 1998) which
rejected the defendant-lender's motion for summary judgment, which
was based on the argument that YSPs are per se legal.
(12) 1997 U.S. Dist. LEXIS 1197
(E.D.Va. Jan. 10, 1997)
(14) Supra; see also Martinez v.
Weyerhaeuser Mortgage Co., U.S. Dist. LEXIS 22172 (S.D. Fla. June
25, 1997). Both cases were decided by Judge Kenneth L. Ryskamp.
(15) Id. at 48-49.
(16) 175 FRD 1 (D. Mass. 1997).
(17) Id. at 10.
(18) 176 FRD 104 (SDNY 1997)
(19) To certify a proposed class
under Rule 23 of the Federal Rules of Civil Procedure, a plaintiff
must show that ``(1) the class is so numerous that joinder of all
members is impractical, (2) there are questions of law or fact
common to the class, (3) the claims or defenses of the
representative parties are typical of the claims or defenses of
the class, and (4) the representative parties will fairly and
adequately protect the interests of the class.''
(20) 1998 U.S. Dist. LEXIS 13248
(D.N.H. Aug. 11, 1998).
(21) Id. at 16-17.
(22) Id. at 16.
(23) Id. For another case in
which a class was certified following Mulligan and distinguishing
Marinaccio and Moniz, see Brancheau v. Residential Mortgage and
Mercantile Bank of St. Louis, 1998 U.S. Dist. LEXIS 14439 (D.
Minn. 1998). It should be noted that both Mulligan and Brancheau
rely on Culpepper's analysis of RESPA even though the court in
Culpepper explicitly refused to decide whether a class should be
(24) 181 FRD 509 (M.D. Ala.
(25) Id. at 37. Other cases in
which motions for class certification were denied include Conomos
v. Chase Manhattan Corp., 1998 U.S. Dist. LEXIS 3135 (SDNY, March
17, 1998); Hinton v. First Amer. Mortgage, 1998 U.S. Dist. LEXIS
2712 (N.D. Ill., March 3, 1998); Barboza v. Ford Consumer Fin.
Co., 1998 WL 148832 (D. Mass., Jan. 30, 1998); and DuBose v. First
Security Savings Bank, 1997 U.S. Dist. LEXIS 22280, (M.D. Ala.,
Oct. 23, 1997).