- The Washington Times - Thursday, April 7, 2005

Q:We live in Frederick, Md., and are considering a zero-cost

refinancing that we learned about through your column. We spoke to two banks, and both said they don’t offer such a program.

One loan officer told me that it couldn’t be done. Can you give a full explanation of how zero-cost refinancing works?

A: Certainly. I have done so in the past many times, and I’m happy to explain again.

First, zero-cost refinancing should not be considered a free lunch; we all know there’s no such thing. The bottom line is this: In exchange for a slightly higher interest rate, usually one-quarter percentage point, a borrower can refinance his house without paying any closing costs. The costs are not rolled into the loan or paid out of pocket.

It doesn’t surprise me that some banks don’t offer such a program. The zero-cost concept became popular when mortgage brokers began using their “yield spread premium” to offset some or all of borrowers’ closing costs.

Let me explain.

Mortgage brokers receive wholesale rates from lenders nationwide. When I say “wholesale,” I mean that the rates offered to the broker usually are cheaper than what a consumer can get if he goes straight to the lender.

This is because the lender requires the broker to perform all the work to get the loan in approvable shape. This includes originating the loan, consulting with the client to find the most compatible program and processing the application package.

When the broker is finished, the lender receives a complete mortgage application package that’s in full legal and underwriting compliance. The lender merely needs to sign off on the loan.

Because the broker receives the lender’s wholesale rates, he can charge a fee to the borrower and still remain competitive in the marketplace.

Here’s where the zero-cost refinancing comes in. Wholesale rate sheets include not just the daily rates on a variety of mortgage programs, but several rates, or “coupons,” for each program.

For example, I see that one of my wholesalers is offering a 30-year fixed rate of 5.625 percent “par.” This means the lender is not charging any points at that rate. (One point is equal to 1 percent of the loan amount.)

The mortgage broker might offer his client 5.625 percent with one point charged to the borrower as his fee.

I also see than the same lender is offering 5.875 percent with a yield spread premium of one point. This means the lender will pay the broker one point. The broker would then quote 5.875 percent with zero points to his client.

Let’s take it a step further: The lender is paying the broker a yield spread premium of two points with an interest rate of 6.125 percent. This is how zero-cost refinancing works.

Even if a refinancing program carries no points, somebody has to come up with the money to pay for the standard closing costs. Somebody, in other words, needs to pay for the appraisal, the credit report, the lender’s title insurance and the county recording fees.

On a $300,000 loan, the refinancing costs will total somewhere near $3,000.

So the broker offers his client a rate of 6.125 percent and agrees to pay all of the borrower’s closing costs. The broker keeps what’s left for his fee.

That’s how it works. The zero-cost refinancing program has been enormously popular over the past 15 years or so because it enables the borrower to refinance his loan without incurring any “sunken” costs.

As long as the zero-cost rate is lower than his current rate, it makes sense. And if we’re in an environment of decreasing interest rates, the borrower needn’t worry about timing the market by locking in at the lowest point. He can merely refinance again because he didn’t incur any fees the first time.

The zero-cost refinancing program has some restrictions. The smaller the loan amount, the more difficult it is to make a no-cost loan. But these programs are indeed available for the right situation. In most cases, taking a higher rate with no closing costs is a better deal than paying thousands in nonrefundable fees.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by e-mail (henrysavage@pmc

mortgage.com).

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