- - Thursday, February 23, 2012

Q. We recently settled on a refinance that supposedly was “zero cost.” When we arrived at the settlement, we were disappointed to find out that we needed a check for more than $2,500.

The settlement officer insisted the loan carried no closing costs, but I just can’t understand how my loan officer advertised his loan as “zero cost” when I had to write a check for $2,500. How can that be zero cost?

A. I’m going to give your loan officer the benefit of the doubt and guess from your email to me that he might be guilty of poor communication skills but not misrepresentation. Being one of the strongest advocates of the zero-cost concept in the industry, I frequently receive the same question. I make sure all my applicants understand the settlement process at the time of application so these questions don’t arise at settlement.

Two things come to mind when I explain how the numbers work on a settlement statement, whether it’s a zero-cost refi or not. First, I tell my applicants not to “overthink” it because it’s really quite simple. Second, I explain to them that whether or not a borrower needs to write a check at settlement has nothing to do with whether closing costs are incurred.

For example, if a borrower applies for a $100,000 loan to pay off an existing loan with a balance of $102,000, the borrower will have to write a $2,000 check at settlement to cover the shortfall. This is not a closing cost. He simply is transferring $2,000 of his personal assets from his checking account to his home’s equity because his mortgage debt will be $2,000 less after the refi.

If the transaction required $3,000 in closing costs and the borrower requested a new loan amount of $100,000, he would need a $5,000 check at settlement, $3,000 of which would be “cost” and $2,000 would be equity.

There are five main components, for lack of a better word, in a typical refinance. First, there is the new loan amount, to be determined at some point before the application goes into underwriting for the approval. Second, there is the payoff amount of the loan being refinanced. This number consists of the existing balance plus any accrued interest owed by the borrower by the time settlement comes.

Third, there are the closing costs, which are fees necessary to get the deal done. Fourth, there is the escrow deposit the new lender will collect in order to make future tax and insurance payments. And fifth, there is prepaid interest the new lender will collect to cover interest owed prior to the due date of the first mortgage payment.

For the borrower to bring no money to settlement, the new loan amount must be equal to the sum of the other four components. If the new loan amount is short, the borrower needs to write a check for the difference.

On a zero-closing-cost option, there is a sixth component: a closing-cost credit. The closing-cost credit must equal the sum of the closing costs for the loan to be a true zero-cost loan.

Whether or not the borrower writes a check at settlement is a case of simple arithmetic. For the borrower to owe nothing and receive nothing at settlement, the equation must look like this: Old Loan Payoff + Closing Costs + Escrows + Prepaid Interest = New Loan Amount + Closing Cost Credit.

Send email to henrysavage@pmcmortgage.com.

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