From the NY Times:
WHEN Gregory and Paula Sherman wanted to refinance the mortgage on their ranch-style home in Chattaroy, Wash., near Spokane, in June 2003, they went to a local mortgage broker.
The broker got them a $267,200, 30-year loan at an 8.5 percent fixed rate with NovaStar Financial.
Or so they thought. The good-faith estimate that the federal government requires mortgage brokers to give to all customers said that was the deal. But at the closing, the Shermans were handed loan documents for an adjustable-rate mortgage with a higher initial rate, of 8.625 percent, that would reset in two years.
They reluctantly signed the documents because they had pressing commitments to pay debts and home renovation contractors. It was only later that they discovered that their mortgage broker was paid a commission of $5,344 by NovaStar to put them into the riskier and more expensive loan. That commission added $200 to their monthly mortgage bill.
Documents in the case show a raft of NovaStar customers accusing the company of using hidden commissions as early as 2003 to generate high-cost loans that may have run afoul of state consumer protection rules.
The Shermans’ suit against NovaStar in late 2005, accusing the company of hiding fees paid to broker in order to increase borrowers’ interest rates, was granted class-action status last year. Discovery in the case turned up a 2003 flier the company sent to brokers that indicated it encouraged them to tap into the company’s capital — its so-called warehouse line — and not to disclose the yield spread premium. It said: “Use Your NovaStar Warehouse Line and close in your name without disclosing YSP!”
The judge overseeing the case asked NovaStar’s lawyer about the practice of charging hidden commissions: “Do you think you are going to sell that to the jury, that it wasn’t a deceptive act or practice?”
When the lawyer answered, “I don’t know, your honor,” the judge said: “I think you have an uphill grind on that one.”
In theory, yield spread premiums are meant to let borrowers pay a higher interest rate over time rather than pay a big sum in closing costs. But Ira Rheingold, executive director of the National Association of Consumer Advocates, said that this was not how they worked.
“In the real world, yield spread premiums give the broker more money, the mortgage lender a loan with a higher-interest payment and Wall Street, which buys the loans, a higher-yielding bond to invest in,” Mr. Rheingold said. “Everyone is happy except the borrower.”