Borrower Paid vs Lender Paid and Each of It's Hurdles

Prior to the great recession, mortgage brokers were compensated through a combination of borrower-paid and lender-paid compensation (also known as Yield Spread Premium, YSP). However, regulation after the real estate crash changed the way mortgage brokers can be compensated (only one or the other), and it's important for borrowers to understand the difference between borrower-paid and lender-paid compensation and how it can impact their mortgage.

Borrower Paid Compensation

Borrower paid compensation refers to fees that the borrower pays directly to the mortgage broker for their services. These fees are typically paid at closing and can include an origination fee, application fee, or processing fee.

Lender Paid Compensation

Lender paid compensation, on the other hand, refers to fees that are paid to the mortgage broker by the wholesale lender as part of the overall cost of the mortgage. These fees are typically paid by the lender as a percentage of the loan amount and are included in the borrower's mortgage rate.Lender-paid compensation is more common in the mortgage industry and has been the subject of much debate in recent years.

Example: Cost & Appearance Difference?

If a mortgage broker decides to make 2% on a loan, and let’s say a 6% rate is giving back 1% in rebate from the lender, there are two options:

1)   Borrower Paid: Where they charge 2% upfront to the borrower (and shows up in a charge in Section A of the Loan Estimate /Closing Disclosure) BUT 1% rebate from the wholesale lender towards other non-broker/lender costs.

2)   Lender Paid: The broker gets paid 2% from the lender directly and because of this, the compensation is built into the mortgage rate. In this case, it’ll show a charge of 1% in Section A of the LoanEstimate / Closing Disclosure. And off to the side on the Closing Disclosure, it’ll show the lender paying the broker 2%.

In the example above, the net cost to the borrower is the same. However, there are certain reasons where you’ll want to use one versus another.

Sometimes Tougher to Pass QM Points & Fees Rule with Lender Paid Compensation

One of the main issues with lender-paid compensation is that it can make it more difficult for a mortgage to meet the QM Points and Fees rule. This rule sets limits on the amount of points and fees that can be charged to the borrower as part of their mortgage. If a mortgage broker is being compensated through lender paid compensation, that compensation must be included in the Points and Fees calculation even if it is being paid by the lender (and borrower isn’t paying any fees). This can make it more difficult for the mortgage to meet the QM Points and Fees rule, particularly on transactions that are higher cost, such as those for low FICO borrowers or investment properties.

What Points Can be Excluded from QM’s Points & Fee Rule?

It's important to note that the QM Points and Fees rule allows for certain points and fees to be excluded from the calculation. For example, you can exclude up to two discount points that are considered"bona fide" (meaning they are charged to all borrowers and are not used as a way to increase the broker's compensation). However, if there is no"par rate" (the rate at which the lender would make the same profit on the loan regardless of the points charged), you cannot exclude all the discount points from the Points and Fees calculation. Here is the full breakdown of how the points and fees are calculated (by the CFPB):

Switching to Borrower Paid to Help Pass QM Points & Fees

Let’s say you’re offering a 6% rate and it’s costing 2% in discount points but you’re also making 2.75% in lender paid compensation (and assume that that’s the lowest fee option – so you can’t exclude the points if there is no par rate; or no rate with fees). Even though the 2.75% isn’t paid by the borrower, the government includes this in the QM Points/Fees rule. You can switch to borrower paid, charge the borrower directly 2.75% and get a .75% lender credit. With lender paid, the government calculates a total of 4.75%points/fees. With the borrower paid, they only consider it 2.75% in points/fees. Even though it ends up being the same net cost to the borrower.

Issue with Borrower Paid (not enough costs to cover if you have a lender credit)

The issue with borrower paid compensation is that if you have a lender credit, that must be used towards non-lender costs. On a lower cost transaction, such as a refinance, you might not have enough costs to be covered.

For example, you’re charging 1% borrower paid compensation on a $500,000 loan and choosing a rate where the borrower is getting 1% back in a lender credit from the wholesale lender; if you don’t have $5000 in other costs, it’ll cause you to have extra lender credit (some programs, like conventional, allow you to use it towards a principal reduction to reduce the loan amount). However, with the extra lender credit if you can’t use it towards costs or a principal reduction, you’ll have to go with a lower rate and get less credit back.

Compliance

At the end of the day, it’s important to have a great compliance team to work with. Disclosure: we are not a compliance company and this is not legal advice. Please consult with an attorney before making any decisions for your business.

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