A federal class-action lawsuit alleging that NovaStar Mortgage overcharged 1,600 borrowers was settled out of court Thursday in Tacoma with...

A federal class-action lawsuit alleging that NovaStar Mortgage overcharged 1,600 borrowers was settled out of court Thursday in Tacoma with the firm agreeing to pay $5.1 million.

The case centered on yield-spread premiums, a legal but controversial practice in which lenders pay independent mortgage brokers a premium to put borrowers into a loan with a higher interest rate than what they qualified for.

Critics charge that these premiums amount to fraud because borrowers often don’t realize they’ve been steered to a higher rate and their loan officer has been financially rewarded for doing so.

Proponents, however, argue that yield-spread premiums are beneficial because such loans usually have lower closing costs.

The NovaStar case was granted class-action certification last October in Tacoma. U.S. District Judge Robert Bryan ruled that NovaStar’s failure to disclose its payment of yield-spread premiums was unfair or deceptive under Washington law.

NovaStar Mortgage, a subsidiary of publicly traded NovaStar Financial, is headquartered in Kansas City, Mo. The suit was set to go to trial when it was settled.

“This case signals to the industry that they cannot treat important borrower disclosures as a nuisance to be avoided or minimized,” John Phillips, the lead class-action lawyer, said in a statement. “Home loans are confusing enough. The least lenders can do is to tell borrowers the critical information that affects their interest rate and closing costs.”

NovaStar denied any wrongdoing and issued a statement saying it settled to avoid further legal costs. NovaStar said that it “appropriately disclosed the yield-spread premiums to the borrowers and that the borrowers did not suffer any actual damages.”

Without the premiums, “the borrowers would have paid the brokers more fees themselves, out of their own pocket,” the company said.

Some $3.3 million of the settlement will be distributed to the homeowners participating in the lawsuit. The remaining $1.8 million will be paid to the two Seattle law firms representing them: Bergman & Frockt and Phillips Law Group.

Elizabeth Rhodes: erhodes@seattletimes.com