Mortgages can be very confusing. The application and the disclosures are often 1/2 inch thick. Distilled to it's essentials, somebody is giving you money, you promise to pay it back and the collateral is the house. The rest has to do with with the Government trying to protect you-from-you and the unscrupulous.

At the end of the day, mortgages are pure finance and thus easy to analyze. Let's talk about some great insider mortgage mysteries and secrets. You should know what the commission to the broker is in advance so that you can make an informed decision and to keep from getting "ripped-off".

How are brokers paid?

Brokers are paid a commission to place mortgages. Lenders publish "rate sheets" and the corresponding commission on a daily basis. Typically they are published several times a day as the market changes. It looks a little like this:

RATE YSP
6.00 (2.25)
5.75 (1.75)
5.50 (1.00)
5.25 (0.50)

The rate is the "interest rate" and the "YSP" (Yield Spread Premium) column represents the commission paid the broker. So, at a rate of 6.00%, the broker receives a commission of 2.25% of the entire loan. Conversely, a rate of 5.5% earns the broker a commission of only 1.00% of the loan amount.

To give you an example: On a $300,000 loan at 6%, the broker will receive $ 6,750.00 (300,000 * 2.25%). Conversely, if the broker writes the loan at 5.50%, the broker will be paid a commission of $ 3,000.00 (300,000 * 1.00%).

When you ask a broker, "How are you paid?" The typical response is a dimissive, "Oh, I get paid from the lender, you don't pay for that." That's partially true. You don't literally pay the commission, but you do in the form of a higher interest rate.

Incidentally, the rate sheet will also have a schedule of modifiers to the YSP. A modifier might be something like a reduction to the commission if the credit score is weak (example: "0.50% charge if score is 620-680") or, if you choose not to escrow your taxes (example: "0.25% if taxes are not escrowed").

So, in this example, if you have a credit score of 650 and you do not want to escrow your taxes, the commission is reduced by the lender in the amount of 0.75% of the loan amount. It is subtracted from the rate sheet above. So, using the schedule above, the commission is now 0.25 % on a 5.5% rate(1.00 in commission minus 0.75 after the modifier) or 1.50% on a 6% rate.

If the broker needs to make at least 1.5% on each deal, the 6% rate might be as low as he can possibly go.

I want a "no-closing cost loan"!

Are you sure you do? There's no such thing as a free lunch.

A "no-closing cost" loan simply means that the broker charged you a higher rate, received a higher commission, then used some of that commission to pay your closing costs.

For example: Assume your closing costs are $2,500.00 and you are insistent on not paying them. The broker will simply build it into the price. Instead of offering you a 5.5% rate, the broker simply quotes you at 6.00%. Using the figures from above, the broker receives $6,750 in commission, applies $2,500 of that towards your costs and makes $3,750 in net commission. Congrats! You now have a "no-closing-cost" loan! Brag to all your friends!

So, what are the true costs of a no-closing cost loan? That's simple, it's the increased rate. In this example, you paid an extra half-point in interest (6.00-5.50%). For a $300,000 loan, that equals $1,500 in extra interest per year. In two years, that equals $3000.00. In other words, you paid 3,000 bucks to save $2,500.00. Wow! What would your friends think now?

Over 30-years, your "no-closing cost" loan cost you an extra $43,500 in interest payments. Hey that's college for your kid.

A no-closing cost loan is an option but not always the best choice for a consumer. If you plan on keeping the loan for a long time, it may not be in your best interest.

I'm not paying points!

Similarly, points can be a friend. In the examples above, if the broker needs to make 1.5% on every loan, perhaps he can give you a rate of 5.25% (which pays the broker .5%) and then charge you 1.00% as a point. The broker makes his required commission of 1.5% and you now have a rate of 5.25% instead of 5.75% which is the next closest rate which pays at least 1.5% with no points.

The savings are same as above. For the price of 1% of the loan, which is $3,000.00, which was paid upfront as a point, you now save 30 years of 0.5% which is $1,500 a year or $43,500 over the life of the loan.

Closing Costs Again

With all this in mind, it's important to know the Yield Spread Premium ("YSP") as well as well as closing-costs. If you're lured into a loan because you are saving a few bucks in closing costs, you might actually be paying thousands more without even knowing it. A smart consumer will ask for the closing costs as well as the YSP.

Don't get Ripped- off

Another important reason for know the commission in advance, is to know whether or not you've been misled by your broker. Unfortunately, there are unscrupulous people in the industry and it's a common practice to quote you low on your Good Faith Estimate then, when it comes time to close, rates have gone up!

If you know the commission that will be made in advance, you will know if rates have really gone up. The commission should be fairly close to what was promised in the beginning. For example, let's assume the broker states that he needs to make 2% on the loan as his commission. If he says, "rates-went-up", but you see that his commission is 3% on the loan documents, you will know you were misled and are paying more than you should.

Knowing YSP is similar to knowing what the "mark-up" on a product. So, if you were buying a car, imagine if you knew exactly what the "mark-up" is. If Dealer "A" marks-up his cars by 6% and Dealer "B" marks-up his cars 10% and both sell the same GM cars, all other things being equal, you'll know what dealer you should shop with confidence.