I am Peter Thompson, My goal is to take the mystery out of the home buying and mortgage process, and help home buyers understand their options.
When rates are down, the biggest obstacle to homeowners lowering their payments and taking advantage of the low rates is the cost of refinancing. As we discussed in the Payback article, the more that the loan costs, the longer you will need to be in the new loan before refinancing makes sense. So if a loan costs a lot upfront, it takes a big improvement in the rates before it is worth doing. On the other hand, if there are no costs at all, a reduction of a small amount in the rates can save you a lot of money over time.
With a no-cost refinance, we are using the yield spread premium (the money that the lenders pay the mortgage broker to bring them the loan) to pay for the closing costs. When we price loans we have several different options. Every day the lenders we deal with send us new price sheets. These sheets have matrixes which allow us (the mortgage banker) to price the loan in different ways. I usually price a loan to show no points or origination fees, but with the normal costs being paid at closing. If someone wants a lower rate, I can price it so that they pay more money upfront and get a lower interest rate. We can also do it the other way, offering them a slightly higher interest rate means that the lender pays us a higher premium, which can then be used to cover all of the loan costs. This program isn’t available with all lenders, but is available with many mortgage brokers or mortgage bankers.
Here is how it works. Let’s say you have a mortgage with a balance of $200,000 and an interest rate of 6.75%. This loan would have a monthly payment of $1,297 for principal and interest. Let’s say that rates drop. If you are able to refinance at 6.0%, your new payment will be $1,199, for a savings of $98 per month with closing costs of $2,000.
If 6.0% is available with closing costs, the rate with no closing costs would be around 6.25% (it would be less if the loan was larger). This means a payment of $1,231 and a savings of $65 per month. The monthly savings are lower, but you save $2,000 up front. This works especially well for people who don’t plan on being in their home or their mortgage for a long period, or if you think that the rate trend is going down and there may be more opportunities to refinance and lower the payments again down the line.
These loans are more attractive when the loan amount is higher. In many cases we can do a no-cost refinance for the same rate as other companies are doing full cost loans. Smaller loans, those under $150,000 are harder to do without any cost. For many people this is the best option.