(This is Part 3 of a three-part series. See Part 1: Who should use no-cost mortgages? and Part 2: Why select a no-cost mortgage?)
A no-cost mortgage is one where the lender charges a higher interest rate in exchange for paying most of the borrower’s settlement costs.
No-cost mortgages in refinancing: In last week’s column I explained that no-cost mortgages are a good deal for refinancing borrowers who don’t expect to have their mortgage very long, and therefore won’t be paying the higher rate very long. No-cost mortgages can also protect refinancing borrowers against being overcharged at the settlement table because the lender committing to no-cost at the outset has no opportunity to raise costs later in the process.
No-cost loans used to refinance 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.
On home purchases, in contrast, only one lender will guarantee settlement costs. Home purchases involve a number of third-party charges that lenders may have difficulty in pricing. The only lender who will guarantee settlement costs on a home purchase is ABN AMRO at www.mortgage.com.
Assuming you meet their underwriting requirements, finding a no-cost fixed-rate or balloon mortgage on www.mortgage.com is a snap. While AMRO does not quote rates on no-cost loans as such, you can find your own from their price tables. The top line in the price table for each type of loan shows their highest rate and lowest total cost. The total cost can be negative if the credit offered as quid pro quo for the highest rate more than covers total settlement costs.
For example, on the 30-year fixed-rate loan of $320,000 that I priced, the top line showed a rate of 6.5 percent with a credit of $727. That means that if I paid 6.5 percent, AMRO would pay my settlement costs, and they would also pay $727 of my down payment or escrows. If I dropped to the second line, the rate would be 6.375 percent and the cost $102 – not quite no-cost, but close.
Borrowers adopting a no-cost mortgage strategy on a home purchase would do well to begin with AMRO’s Web site, unless you are shopping for an adjustable-rate mortgage (ARM). AMRO does not quote no-cost rates on ARMs.
You can also roll your own no-cost loan at E-Loan and Indy Mac. Both of these lenders guarantee their own fees, but not third-party fees, which are only estimates. If the estimate turns out too low, you will be liable for some fees you thought were covered. If the estimate turns out too high, your costs will turn out to be lower than you expected.
This isn’t as good as having third-party fees guaranteed, but it isn’t that bad either. Since both lenders show their detailed estimates of third-party charges, you can get an idea of how large an error might be by comparing their estimates. Unlike AMRO, furthermore, E-loan and Indy Mac quote no-cost rates on ARMs having initial rate periods of 3 years and longer.
If you have a long time horizon, you cannot use these sites to obtain a “semi-no-cost mortgage,” on which the lender pays the costs other than points, and the borrower pays points to reduce the rate. This tactic, which I recommended last week for borrowers who are refinancing, is designed to avoid cost escalation as the loan moves toward closing. This danger does not arise, however, if you use lenders who guarantee their own fees.
No-cost loans, and semi-no-cost loans can be arranged through brokers. The only cost that a broker can guarantee, however, is her own and most brokers are reluctant to do even that. The exception is Upfront Mortgage Brokers (UMBs), who will guarantee their own fees. Brokers also know the fees of the lenders with whom they work, so lender fee escalation is seldom an issue. Broker capacity to estimate third party fees will vary widely, but if the broker’s fee is fixed, under-estimates should be no more likely than over-estimates.
The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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