by Alex Stenback on September 22, 2011
Refinancing can be expensive . But it does not have to be.
That’s because, with a little bit of creative thinking, or if you are working with a lender that knows what they are doing (and probably does not work under the thumb of a major national bank,) your lender will pay your costs for you.
This means: No closing costs. Zero. Nothing added to the loan or paid outright.
Sounds like the best deal ever, right?
Why doesn’t everyone refinance this way?
To understand why, and how this works, we need to wade – briefly - into the topic of how mortgage interest rates are offered, or priced.
Stay with me here.
Repeat After Me: There’s No Such thing as “Today’s Rate”
“What’s the 30 year rate today?”
Whether I am at a cocktail party (confession: I don’t think I have ever been to a “cocktail party”) or picking up the phone, it is a question I hear all the time.
It echoes in my head, and will probably be engraved on my tombstone.
And it is the wrong question.
That’s because there simply is no “rate” issued each day by the powers that be. There is a schedule, or “stack” of rates – each with a corresponding price.
Here’s a grossly (laughably) oversimplified version of what lenders see every day when rates are released:
Actual rate sheets are a good deal more complicated than what you see here - many more decimals and adjustments to price based on myriad factors, but the central point to be made is this:
On any given day, no matter the overall interest rate levels,
- Lower rates are more expensive than higher rates and require a borrower to pay points.
- You can also receive, or be paid points for a higher rate.
The No-Cost Refinance, Explained
Once you undertsand the concept that there is no “rate” but rates, and you can both pay or be paid points, understanding the no-cost refinance is straightforward.
By accepting a higher rate (but still much lower than your current rate, of course) the lender will use the premium paid for that rate (sometimes called “yield spread premium”) to pay your costs.
This is why no-cost refinancing can make so much sense. In the simplest of terms: You lower your mortgage rate, and pay nothing to do so.
For instance: If you are starting at a rate of 5.5%, and you can a) refinance to 4% without paying closing costs, or b) refinance to 3.75% and pay thousands. Which do you choose?
It is awfully hard to build a case for ever paying closing costs unless you know that you will own the home and have the mortgage for the very, very long term.
Bottom line: The additional savings at the incrementally lower “full cost” rate rarely justifies the expense.
*With a No-Cost, even if you are wrong, you are right
The other great thing about the no-cost refinance? You never need to time the market. You need never hope that you “guessed right” or beat yourself up if rates fall again.
you have paid zero costs, there is zero risk. If rates keep falling, you just do another no cost. Wash, rinse, repeat.
Bottom-Bottom Line: If you are disciplined about doing a no-cost refinance every time rates drop, you effectively guarantee that no matter what happens to interest rates, you will always be within 1/2 point of the lowest mortgage rates ever get, and will never pay a dime to do so.
Finally, despite my erudite clumsy attempt to explain a no-cost refinance above, sometimes it just does not click until you see the no-cost numbers run out against your own loan – there’s got to be a hook, or a catch somewhere, right?
Anyway, if the idea intrigues you, but you are unsure how this might work in your particular situation (or worried about the hook!) drop me a line and I’d be happy to personally run-out the numbers for you.
Becuase when it does click, you will say the same thing as everyone else: “Why doesn’t everybody do it this way”
*A Few Cautionary Notes:
Before you run off seeking a no-cost refinance, it is important to understand a few nuances, and that a no-cost refinance will not work for everyone.
If you are escrowed for taxes and insurance. you will be required to establish an escrow account on the new loan – this will normally mean a cash outlay at closing (assume about 6 months taxes and 6 months insurance, but it varies based on the time of year and what state you are in.) This generally works out a wash – your current escrow balance will be a refund within 30 days of closing, and you’ll skip your regularly scheduled mortgage payment the first of the month following the refinance.
If you are really pressed for cash, most lenders will allow you to add escrow amounts to the loan.
Appraisals matter . Unless you are refinancing an FHA mortgage, you will need an appraisal to refinance, and despite the expanded rules of the Home Affordable Refinance Program, many in-the-money refinances that should happen, won’t, due to lack of equity.
Loan Amounts matter. As a general rule, the bigger the loan (up to the conforming limit of $417,000 in MN) the easier it is to do a no-cost. That’s because the premium paid for the higher rate is paid as a percentage of the loan amount. 1% of $50,000 is $500.00. 1% of 300,000 is $3,000, which goes a lot further to cover closing costs, many of which are fixed, no matter the loan size.
Steer clear of major national banks that also service mortgages. N0-costs are mostly considered kryptonite by these banks. This is because they also have an interest in the servicing of the loan, and can actually lose money by doing too many no-costs. As a result, they often will do everything they can to talk you out of these, and generally offer weak premiums for above market rates.
Thinking about refinancing? Need a no-cost rate quote?
Whether a no-cost, or not, drop me a line with a few bullet points about what you are looking to do and I will personally reply in short order with some solid numbers.