The No-Cost Thirty Year Fixed Rate Mortgage
There really is no such thing as a "no-cost" mortgage loan. There are always
costs, such as appraisal fees, escrow fees, title insurance fees, document fees,
processing fees, flood certification fees, recording fees, notary fees, tax service
fees, wire fees, and so on, depending on whether the loan is a purchase or a
refinance. The term "no-cost" actually means that your lender is paying the costs
of the loan. All a "no cost" loan means is that there is no cost to you, the borrower.
Except that you pay a higher interest rate.
Understand How Loans Are Priced
A variation of the no-cost loan is the "no points" loan, or even the "no points, no
lender fees" loan. On these loans you pay all the costs associated with buying a
house or refinancing, but you do not have to pay the lender associated fees or
points. However, since lenders and loan officers do not do anything for free, the
profit has to come from somewhere.
So where does it come from?
First, you have to understand how loans are priced and how mortgage lenders
and loan officers earn income. Each morning mortgage companies create rate
sheets for loan officers. The rates usually change slightly from day to day. In
volatile markets they change several times a day. On the rate sheet, there are
many different programs, including the thirty year fixed rate.
There will be one column which will lists several different interest rates and
another column that lists the "cost" for that particular rate. For example:
Rate Cost(points)
====== =============
6.250% 2.000
6.375% 1.500
6.500% 1.000
6.625% 0.500
6.750% 0.000
6.875% (0.500)
7.000% (1.000)
7.125% (1.500)
7.250% (2.000)
In the above example, 6.75% has a "par" price, which means it has a zero cost.
The lower in rate you go, the higher the cost, or "points." A point is equal to one
percent of the loan amount. The parentheses in the cost column for the higher
interest rates indicates a negative number. For example, (1.500) equals -1.500,
which means instead of having a cost associated with the loan, the lender is
willing to pay out money for those interest rates. This is called "premium" or
"rebate" pricing.
-- Zero Cost Loans --
How Mortgage Companies and Loan Officers Make Money
The above rate sheet is not a rate sheet designed for public review. In fact, most
lenders have a policy that the public cannot see their internal rate sheet. This
rate sheet is designed for loan officers and the cost column is the loan officer's
cost, not the cost to the borrower. When the loan officer quotes you an interest
rate, he will add on a certain amount, usually one to one and a half points. Most
companies leave it up to the loan officer's discretion how much to add on to the
base cost. However, they usually require at least a minimum add-on, which is
usually one point.
The loan officer's commission depends on his "split" with the company and can
vary. He receives a portion of the add-on and the rest goes to the company.
If we assume the loan officer is adding on one point, and you were willing to pay
one point for your loan, then your rate would be (according to this rate sheet)
6.75%. You would pay one percentage point and receive an interest rate of six
and three-quarters. If you wanted a lower rate and were willing to pay two points,
you could get six and a half percent. If you wanted a "no points" loan, then your
rate would be seven percent. The loan officer and the mortgage company would
split the one point rebate, listed as (1.000) on the rate sheet.
See how it works?
In addition to the cost noted on the rate sheet above, lenders have certain other
fees they like to collect, too. These can include document fees, processing fees,
underwriting fees, warehouse fees, flood certification fees, wire transfer fees, tax
service fees, and so on. Usually, you will not be charged all of these fees, it is
just that different lenders call them different things. Some of them are legitimate
costs to the lender and some of them are simply fees designed to generate
additional income to the mortgage company. They are customary in today's
mortgage market and can vary from around $600 to $1300. In addition, there will
usually be an appraisal fee and a credit report fee. Appraisals and credit reports
are usually contracted out to independent companies even though these are
considered to be lender fees.
Note that it is common for companies who charge higher fees to have a slightly
lower interest rate and companies that charge lower fees will usually have a
slightly higher interest rate. So if you shop entirely based on fees, you may
actually spend more money in the long run because your interest rate may be
higher.
The point is that if you want a "no points - no lender fees" loan, then on our rate
sheet above, you may get an interest rate of 7.125%. That is because the loan
officer has to bump the interest rate even further than on a "no points" loan in
order to cover his own company's fees.
If you want a "no cost" loan, then the loan officer has to bump your interest rate
even further. That is because all of the costs on your purchase or refinance do
not come from the lender. The escrow or settlement company involved in your
transaction will charge a fee which must be paid. The lender will require title
insurance and the title insurance company charges a fee for providing this
insurance. If your new lender requires information from your homeowner's
association (if you have one) then the homeowner's association will most likely
charge a fee for providing those documents. If you are refinancing, your current
lender will usually charge at least two fees: a "demand" fee, and a
"reconveyance" fee. The demand fee is charged simply for providing payoff
information. The reconveyance fee is charged because your current lender
prepares a document which releases your property as collateral for their
outstanding loan. This document is called a reconveyance.
These charges will add about another point to how much the loan officer must
collect in premium pricing in order to cover the costs associated with your
refinance or purchase. For a zero cost loan, he will normally need to collect
somewhere in the neighborhood of two and a half points. Because points are a
percentage of your loan amount and most of the costs are fixed, it takes fewer
points to provide zero costs on higher loan amounts. On smaller loan amounts it
takes more. One percent of $200,000 is two thousand dollars and one percent of
$100,000 is only $1000, so you can see how it is easier to cover costs on larger
loans.
Does it makes sense to do a zero cost loan?
On a $200,000 thirty year fixed rate loan, the difference in monthly mortgage
payments will be about $87, using the example rate sheet on the first page. Over
thirty years, it works out that you will pay more than $30,000 extra for getting a
zero cost loan. So if you intend to remain in the home for a long period of time it
just doesn't make sense.
Suppose you intend to stay for only five years? On a purchase, using the
$200,000 example, if you stayed longer than fifty-five months, it would make
more sense to pay your own costs and get the lower interest rate. If you kept the
loan for a shorter time, then it makes more sense to pay zero costs and get a
higher interest rate.
Except for one thing.
If you knew you were only going to be staying in the home for five years you would
probably not want a thirty year fixed rate, anyway. You would get a loan which has
a fixed payment for the first five years, then convert to an adjustable or whatever
fixed rates are five years from now. These loans have an interest rate almost a
half percent lower than thirty year fixed rate loans. Since it is practically
impossible to do a zero cost loan on this type of loan, you would have to
compare a zero cost thirty year fixed rate loan to paying points on a loan with a
fixed payment for five years.
The difference in payments would be about $150. The two and a half point rebate
equals $5000. Working out the math, if you stayed in the home longer than
thirty-three months, it would make more sense to pay the points and get the loan
with the five year fixed rate.
Finally, carry the discussion one step further. Suppose you know you are going to
be in the new loan for less than three years? Doesn't it make sense to get a
"zero cost" loan then?
No.
Then you get an adjustable rate loan. As long as the start rate is two percent
lower than the current fixed rate, you cannot lose. The first year you will save a lot
of money. The second year you will probably break even. The third year, you will
probably give up some of the savings from the first year, but not all of them.
"Zero cost" loans just don't make sense for homebuyers.
But they sound really good in an advertisement.
Exceptions:
On a FHA Streamline Refinance Without an Appraisal (not a purchase - which is
what the article talks about), it makes sense to do a zero cost loan. This is
mostly because the new loan has to be exactly the same amount as the existing
balance of the current loan.
If the homebuyer only has enough money for down payment and none to cover
closing costs, PLUS no arrangement can be made for the seller to pay closing
costs, then zero costs may make sense (however, I would still recommend
negotiating terms with the homeseller - be willing to pay a higher price in
exchange for the seller paying your costs)
costs, such as appraisal fees, escrow fees, title insurance fees, document fees,
processing fees, flood certification fees, recording fees, notary fees, tax service
fees, wire fees, and so on, depending on whether the loan is a purchase or a
refinance. The term "no-cost" actually means that your lender is paying the costs
of the loan. All a "no cost" loan means is that there is no cost to you, the borrower.
Except that you pay a higher interest rate.
Understand How Loans Are Priced
A variation of the no-cost loan is the "no points" loan, or even the "no points, no
lender fees" loan. On these loans you pay all the costs associated with buying a
house or refinancing, but you do not have to pay the lender associated fees or
points. However, since lenders and loan officers do not do anything for free, the
profit has to come from somewhere.
So where does it come from?
First, you have to understand how loans are priced and how mortgage lenders
and loan officers earn income. Each morning mortgage companies create rate
sheets for loan officers. The rates usually change slightly from day to day. In
volatile markets they change several times a day. On the rate sheet, there are
many different programs, including the thirty year fixed rate.
There will be one column which will lists several different interest rates and
another column that lists the "cost" for that particular rate. For example:
Rate Cost(points)
====== =============
6.250% 2.000
6.375% 1.500
6.500% 1.000
6.625% 0.500
6.750% 0.000
6.875% (0.500)
7.000% (1.000)
7.125% (1.500)
7.250% (2.000)
In the above example, 6.75% has a "par" price, which means it has a zero cost.
The lower in rate you go, the higher the cost, or "points." A point is equal to one
percent of the loan amount. The parentheses in the cost column for the higher
interest rates indicates a negative number. For example, (1.500) equals -1.500,
which means instead of having a cost associated with the loan, the lender is
willing to pay out money for those interest rates. This is called "premium" or
"rebate" pricing.
-- Zero Cost Loans --
How Mortgage Companies and Loan Officers Make Money
The above rate sheet is not a rate sheet designed for public review. In fact, most
lenders have a policy that the public cannot see their internal rate sheet. This
rate sheet is designed for loan officers and the cost column is the loan officer's
cost, not the cost to the borrower. When the loan officer quotes you an interest
rate, he will add on a certain amount, usually one to one and a half points. Most
companies leave it up to the loan officer's discretion how much to add on to the
base cost. However, they usually require at least a minimum add-on, which is
usually one point.
The loan officer's commission depends on his "split" with the company and can
vary. He receives a portion of the add-on and the rest goes to the company.
If we assume the loan officer is adding on one point, and you were willing to pay
one point for your loan, then your rate would be (according to this rate sheet)
6.75%. You would pay one percentage point and receive an interest rate of six
and three-quarters. If you wanted a lower rate and were willing to pay two points,
you could get six and a half percent. If you wanted a "no points" loan, then your
rate would be seven percent. The loan officer and the mortgage company would
split the one point rebate, listed as (1.000) on the rate sheet.
See how it works?
In addition to the cost noted on the rate sheet above, lenders have certain other
fees they like to collect, too. These can include document fees, processing fees,
underwriting fees, warehouse fees, flood certification fees, wire transfer fees, tax
service fees, and so on. Usually, you will not be charged all of these fees, it is
just that different lenders call them different things. Some of them are legitimate
costs to the lender and some of them are simply fees designed to generate
additional income to the mortgage company. They are customary in today's
mortgage market and can vary from around $600 to $1300. In addition, there will
usually be an appraisal fee and a credit report fee. Appraisals and credit reports
are usually contracted out to independent companies even though these are
considered to be lender fees.
Note that it is common for companies who charge higher fees to have a slightly
lower interest rate and companies that charge lower fees will usually have a
slightly higher interest rate. So if you shop entirely based on fees, you may
actually spend more money in the long run because your interest rate may be
higher.
The point is that if you want a "no points - no lender fees" loan, then on our rate
sheet above, you may get an interest rate of 7.125%. That is because the loan
officer has to bump the interest rate even further than on a "no points" loan in
order to cover his own company's fees.
If you want a "no cost" loan, then the loan officer has to bump your interest rate
even further. That is because all of the costs on your purchase or refinance do
not come from the lender. The escrow or settlement company involved in your
transaction will charge a fee which must be paid. The lender will require title
insurance and the title insurance company charges a fee for providing this
insurance. If your new lender requires information from your homeowner's
association (if you have one) then the homeowner's association will most likely
charge a fee for providing those documents. If you are refinancing, your current
lender will usually charge at least two fees: a "demand" fee, and a
"reconveyance" fee. The demand fee is charged simply for providing payoff
information. The reconveyance fee is charged because your current lender
prepares a document which releases your property as collateral for their
outstanding loan. This document is called a reconveyance.
These charges will add about another point to how much the loan officer must
collect in premium pricing in order to cover the costs associated with your
refinance or purchase. For a zero cost loan, he will normally need to collect
somewhere in the neighborhood of two and a half points. Because points are a
percentage of your loan amount and most of the costs are fixed, it takes fewer
points to provide zero costs on higher loan amounts. On smaller loan amounts it
takes more. One percent of $200,000 is two thousand dollars and one percent of
$100,000 is only $1000, so you can see how it is easier to cover costs on larger
loans.
Does it makes sense to do a zero cost loan?
On a $200,000 thirty year fixed rate loan, the difference in monthly mortgage
payments will be about $87, using the example rate sheet on the first page. Over
thirty years, it works out that you will pay more than $30,000 extra for getting a
zero cost loan. So if you intend to remain in the home for a long period of time it
just doesn't make sense.
Suppose you intend to stay for only five years? On a purchase, using the
$200,000 example, if you stayed longer than fifty-five months, it would make
more sense to pay your own costs and get the lower interest rate. If you kept the
loan for a shorter time, then it makes more sense to pay zero costs and get a
higher interest rate.
Except for one thing.
If you knew you were only going to be staying in the home for five years you would
probably not want a thirty year fixed rate, anyway. You would get a loan which has
a fixed payment for the first five years, then convert to an adjustable or whatever
fixed rates are five years from now. These loans have an interest rate almost a
half percent lower than thirty year fixed rate loans. Since it is practically
impossible to do a zero cost loan on this type of loan, you would have to
compare a zero cost thirty year fixed rate loan to paying points on a loan with a
fixed payment for five years.
The difference in payments would be about $150. The two and a half point rebate
equals $5000. Working out the math, if you stayed in the home longer than
thirty-three months, it would make more sense to pay the points and get the loan
with the five year fixed rate.
Finally, carry the discussion one step further. Suppose you know you are going to
be in the new loan for less than three years? Doesn't it make sense to get a
"zero cost" loan then?
No.
Then you get an adjustable rate loan. As long as the start rate is two percent
lower than the current fixed rate, you cannot lose. The first year you will save a lot
of money. The second year you will probably break even. The third year, you will
probably give up some of the savings from the first year, but not all of them.
"Zero cost" loans just don't make sense for homebuyers.
But they sound really good in an advertisement.
Exceptions:
On a FHA Streamline Refinance Without an Appraisal (not a purchase - which is
what the article talks about), it makes sense to do a zero cost loan. This is
mostly because the new loan has to be exactly the same amount as the existing
balance of the current loan.
If the homebuyer only has enough money for down payment and none to cover
closing costs, PLUS no arrangement can be made for the seller to pay closing
costs, then zero costs may make sense (however, I would still recommend
negotiating terms with the homeseller - be willing to pay a higher price in
exchange for the seller paying your costs)
Still have questions? Contact me today for a free
consultation!
consultation!
Colin O’Neal
Buyer’s Agent
200 North Rufe Snow Drive, Ste.102
Keller, TX 76248
(817) 898-0145 Office
(817) 898-1771 Fax
colin@househuntersdfw.com
Buyer’s Agent
200 North Rufe Snow Drive, Ste.102
Keller, TX 76248
(817) 898-0145 Office
(817) 898-1771 Fax
colin@househuntersdfw.com
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