I have a question regarding rebates. Why do some lenders have such low maximum above-par pricing on certain products, especially ARMs? This sometimes precludes me from offering reduced and no-closing cost loans. I was told it has to do with the investors on the secondary market. Why would the investors care? Thank you, James, Sacramento, CA

There are several reasons that lenders have maximum yield spread premiums on certain products—

• First, they may be afraid of brokers charging too much and moving in non-QM lending territory. Therefore, they may limit either rebates and/or total compensation charged by the broker.
• Second--if they can't sell the loan too far "over par" this will limit the rebate. Why would this be the case? Using hypothetical even numbers, if you had a three-one adjustable and par is 4.0% and 30-year fixed-rate par is at 5.0%, when you buy the adjustable up to 5.0%, this will likely be a short-term loan because the customer is more likely to refinance quickly if rates go down. Why would someone stay in a 5.0% three-one ARM when fixed rates are 5.0%?
• Third--accounting regulations will limit rebates when loans are originated for a portfolio rather than for sale. It is more likely that ARMs are originated for a portfolio rather than fixed rates because these loans limit the bank's future risk. If they pay you "two" and then sell the loan on the secondary market--they get that "two" right back. If they are holding it in the portfolio, the expense of paying you is up front--but they don't get that income right away. So, the loan is originated at a loss that is recovered over time through a higher rate. I am not an expert in this, but I have served on the board of a bank and have gone through the process with accounting firms. You never want to become an expert in FASB accounting standards unless you are a CPA or an auditor.

Keep in mind that secondary trends change over time. For generations, jumbo pricing was more expensive than conforming pricing.  This was because the secondary markets for conforming, led by Fannie and Freddie, were more efficient.  But when the secondary markets collapsed during the financial crisis, jumbo spreads went up initially. Big banks were forced to hold onto jumbo loans, and they started pricing these loans differently.  Getting hungry for products, some banks offered pricing even lower than conforming. This has gone on for some time.

Likewise, the efficiency of on-line lenders such as Quicken have enabled more borrowers to refinance more quickly during the past several years. This has compressed the premiums offered above par recently – even on fixed rate loans. Will these premiums come back as rates go up and refinances diminish? Only time will tell.

Hope this helps.

Dave