Refinance plan takes rate higher

Q:I have been watching rates drop over the past few weeks and am considering

refinancing our home and rolling in a loan on a time share we have.

I have read many times in the Home Guide that you recommend the “no-cost” plan that eliminates the closing costs in exchange for a higher rate. Our credit is great, but my husband and I don’t have a lot of income, at least not yet.

My husband’s salary is $75,000, and I have just started a business selling items via Internet auction. We are seeking a $575,000 loan with an interest-only feature to keep our payments down until my business gets going.

The property is worth at least $750,000. We applied for a “no cost” refinance and were quoted an interest-only fixed rate at 7.75 percent. One of your recent articles pointed out that no-cost refinancing should carry a rate around 6.25 percent. What gives?

A: In recent columns, I have been using 6.25 percent as the market rate as an example for a zero-cost refinancing on a $300,000, 30-year, fixed-rate loan program. Indeed, 6.25 percent certainly should be the market rate for such a program. In fact, as of this writing, I see that I could offer 6.125 percent, thanks to dropping interest rates.

You have provided me with enough information to surmise why your zero-cost quote is so much higher. Let me try to explain.

First, your loan amount falls into the “nonconforming,” or “jumbo” territory. Loan amounts that exceed $417,000 carry a higher interest rate. I see that a standard jumbo 30-year fixed rate will run about 6.625 percent. The borrower would have to pay the standard closing costs with this rate, which would run in the $4,300 range, depending upon the state in which you live.

As you point out, the zero-cost program will carry a rate that’s about 1/4 percent higher. There’s no free lunch with zero-cost refinancing.

Nevertheless, most homeowners are better off taking a slightly higher rate and eliminating $4,300 in sunken fees. Remember that closing costs are not tax deductible, but mortgage interest is, one of many reasons to consider a zero-cost option.

A jumbo zero-cost refinancing loan might run in the range of 6.875 percent for a fixed rate. Why were you quoted a much higher rate of 7.75 percent? There are several reasons.

First, most lenders will bump the rate slightly for an interest-only payment feature.

Second, I can predict that your loan officer is quoting a “no-documentation,” or “no-doc” loan, which typically carries a significantly higher rate. Don’t confuse a no-doc loan with the popular “stated-income” loans, which often carry little or no rate increase.

The difference is simple.

A stated-income program requires you to disclose your income on the application without verification. A no-doc loan states nothing.

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