The current refinance boom has focused attention on no-cost mortgages (NCMs), which have attractive features to refinancing borrowers. NCMs help borrowers avoid being overcharged, and they eliminate most of the uncertainty involved in determining whether a refinance will pay. Most importantly, it allows a borrower to refinance again should rates drop even slightly.
What Are No-Cost Mortgages?
A no-cost mortgage is one on which the lender pays the borrower’s settlement costs, with the following exceptions:
* Per diem interest, which is interest from the closing date to the first day of the following month, isn’t included because it is not known until the exact closing date is set.
* Escrows for taxes and insurance, which are borrower funds set aside to assure payment of the borrower’s future obligations, are not covered because they are not a cost of the transaction.
* Homeowners’ insurance is not covered because, while required by the lender, it also benefits the borrower. Owner’s title insurance is not covered because it is optional or paid by the seller.
* Transfer taxes, if any, are not covered because the amount is sometimes uncertain, and it is set by a governmental entity.
All other costs, including the mortgage broker’s fee if there is one, are paid by the lender.
No-Cost Mortgages Help Protect Against Being Overcharged
In selecting a loan provider, borrowers typically shop for rate and points, ignoring other settlement costs. They usually find out about these costs after they submit an application, and then they receive "estimates" that are subject to change. This provides lenders with ample opportunities to pad their own fees and mark up those of third parties.
When responding to a borrower inquiring about a no-cost loan, however, lenders do not have that luxury. A borrower shopping for a no-cost loan has only one price to consider -- the interest rate -- and lenders have to assume that they are being rate shopped. The rates they quote, therefore, are likely to cover their true costs, which could be well below the costs faced by borrowers who don’t go the no-cost route.
No-Cost Loans Can Also Limit Broker Fees
On no-cost loans that go through brokers, the broker’s fee is an additional cost that must be covered by the rate. This can limit broker fees because lenders cap the rebates they are prepared to offer for higher interest rates.
A recent study of brokered loans by Susan Woodward showed that total settlement costs including broker fees were $1500 lower on no-cost than on other loans. While no breakdowns were available, it is likely that most if not all of the $1500 was lower broker fees.
A No-Cost Shopping Strategy For Refinancing Borrowers
On a refinance, no-cost loans are widely available because most lenders are prepared to assume full responsibility for settlement costs. Most of the settlement costs on a refinance are lender fees, and the third party services that generate charges (such as appraisal or credit) are often waived. Guaranteeing settlement costs involves little risk to the lender.
Borrowers can shop for the lowest no-cost rate, and can shop brokers and lenders interchangeably. They need not concern themselves with brokers’ fees because the fees are covered by the rate.
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