April 4th, 2011 11:03 PM by Robin Bain
A Service Release Premium (SRP) is the payment received by a lending institution, such as a bank or retail mortgage lender, on the sale of a closed mortgage loan to the secondary mortgage market. The secondary mortgage market purchaserr is typically a Wall Street investment bank, Fannie Mae, Freddie Mac, or Ginnie Mae, as the first step in the creation of a mortgage-backed security (MBS). Today, virtually all mortgages closed today are purchased by the US government through the GSE Mortgage Backed Securities Purchase Program
The amount of SRP paid is based on the market value of the mortgage note, influenced by several key variables, such as interest rate, loan type, margin (for ARM loans), and the inclusion or exclusion of other items such as prepayment penalties. Also considered are the loan's LTV (loan to value), the borrower's credit score, the presence of Private Mortgage Insurance (PMI), pre-payment risk of the borrower and other factors beyond the scope of this article.
Since revenue generated through SRP is directly related to the terms of the loan for sale, banks are financially incentivized to structure loans profitably. Naturally, when they're able to, lenders add items such as pre-payment penalties, increase the margins on ARM loans, select ARM indices which are unstable, and of course, sell higher interest rates to borrowers in order to increase their SRP revenue.
When direct lenders, banks, and institutional sell their loans directly to the secondary market, the SRP they earn does not have to be disclosed to the borrower/consumer. This does not seem unreasonable, as this is generally how free-markets work. For example, the baker does not have to tell the customer what he pays for flour, the grocer doesn't disclose his wholesale price for food.
When third party originators (TPO's), such as mortgage brokers originate loans, they don't earn Service Release Premium. Mortgage brokers do however have a similar incentive to earn additional revenue based on the terms of the loans their borrowers accept. This revenue is paid by the wholesale lender the broker called "yield spread premium (YSP)."
Mortgage brokers earn a fee by putting buyers and banks together, arranging a loan and presenting a qualified borrower and all their documentation to a lender for funding.
All YSP fees earned by a mortgage broker must disclosed to the borrower, up front. The disclosure of YSP vary from state to state. In Florida, for example, the borrower must be disclosed the total YSP the broker earns from the wholesale lender upfront, as a maximum dollar amount, within three days of applying for a loan. This must occur before the broker is allowed to collect any fee for any services from the borrower, except for a reasonable credit bureau report fee. Banks have no such restrictions on their SRP. Why must the SRP remain in the shadows?
The argument the bank can't calculate the amount of SRP they're likely to earn is a red herring, as behemoth financial institutions like Wells Fargo and JPMorgan Chase do have an ability to obtain forward commitments from Wall Street investment banks and GSE's Fannie Mae, Freddie Mac, and FHA loan secondary market purchaser Ginnie Mae for funds based on long-standing agreements. (This completely ignores the fact that FNMA, GNMA, and Freddie Mac purchase the collateral (security instrument) for the loans sold on the secondary market for securitization, not the servicing. SRP does not apply here, either. Servicing is either retained by the mortgage bank selling the mortgage, or it is sold separate from the security instrument to a loan servicer. Then, and only then, is SRP realized).
To the consumer, the incentives for a broker to earn YSP are the same as the bank's to earn SRP, as the two share an identical purpose - additional revenue earned by the originating institution, in exchange for less favorable loan terms for their customer. (Actually, mortgage banks have a decent incentive for offering reasonable terms to their borrowers - an interest rate substantially higher than par will result in DECREASED SRP, not increased. Why? The loan has a lower expected life before refinance or default.) At least consumers have a fighting chance when the broker discloses their YSP.
Members of the US Senate Banking committee, in a December 24, 2009, open letter to Federal Reserve Chairman Bernanke, called for the Fed to immediately eliminate the mortgage broker's yield spread premium, claiming the payment of YSP to brokers is at the center of the current housing and economic crisis. Curiously, the committee did not address the payment of SRP to lenders in their letter to the Chairman.
Mortgage Brokers are treated differently, and arguably, less fairly, as they must disclose their YSP to borrowers, while banks and institutional lenders continue to earn SRP with no consumer disclosure whatsoever. What gives here? (Exactly how a mortgage banker can disclose an indeterminate value to the borrower potentially weeks or months before the closed loan is sold on the secondary market, earning SRP revenue that is not nearly as predictable as suggested in this article, is another matter entirely.)
This difference in treatment has led to consumer confusion, and also confusion among lay-persons with the best intentions. The existence of YSP has been under fire for several years by politicians like Senator Christopher Dodd, former HUD Secretary and current Florida Senator Mel Martinez and consumer groups such as the Center for Responsible Lending.
All the while, banks continue to earn SRP without anyone questioning the revenue and lack of transparency involved.