Do All Lenders Offer No-Cost Mortgages?

September 4, 2007, August 21, 2011

This article examines the claim that Bank of America’s new no-fee program for house purchasers, under which lender and third party fees are absorbed by the bank, is not novel because all lenders offer no-cost loans. The claim has little validity, because most borrowers don't know how to "roll their own" no-cost loan, and even if they do, other lenders do not guarantee their quoted costs. See No-Cost Mortgages. An exception is Upfront Mortgage Lenders, who do guarantee their costs, though not those of third parties.

The Bank of America Mortgage

In a recent article I examined Bank of America’s new no-fee program for house purchasers, under which lender and third party fees are absorbed by the bank. (See NoFeeMortgagePlus: Is Bank of America a White Knight?) On a fixed-rate mortgage, the borrower pays the interest rate and points, and that’s it. Price shopping would be so much easier, I mused, if all lenders did the same.

A spokesman for another large lender responded to that article by claiming that other lenders do offer the same product, they just give it a different name; they call it a "no-cost mortgage".

Other No-Cost Mortgages

I will explain what he means with an over-simplified example. A lender who absorbs all costs in its rate and points must mark up the price accordingly. For example, if B of A is prepared to absorb $3,000 of costs including third party charges to acquire a $300,000 loan at 6%, it will price a no-fee loan at 6% and 0 points.

Now consider Lender X offering the same loan, and faced with the same $3,000 in costs except that the costs are billed to the borrower. This lender offers 6% at -1 point, which is a rebate to the borrower. The borrower selecting the 6% mortgage on which the rebate just covers the $3,000 has a no-cost mortgage from X that appears identical to that of B of A’s.

In other words, the borrower from B of A pays 6% and nothing else. The borrower from X pays 6% plus $3,000 in fees but receives a $3,000 rebate from X.

Not All No-Cost Mortgages Are Alike

But note a critical difference. The $3,000 charged the borrower by X is probably not guaranteed. A few lenders guarantee their own fees (see below), even fewer guarantee third party fees. All the rest provide estimates, which sometimes have a funny way of escalating as loans move toward closing. So the borrower dealing with X might end up with a rebate worth $3,000 and be billed for $4,000 in costs. That can’t happen with the B of A mortgage.

Most borrowers are not aware of the no-cost option from lenders other than B of A. The loan officers and mortgage brokers with whom they deal are unlikely to volunteer the information because no-cost loans are easier to comparison shop. If the borrower requests a no-cost quote, they will comply, but the quotes are based on cost estimates that can be far off the mark.

Finding a No-Cost Mortgage On-Line

Borrowers can roll their own no-cost mortgage on-line. They do this by selecting an interest rate that carries a rebate large enough to cover the settlement costs. This requires that they have access to the complete range of rate/point combinations offered by the lender, as well as the settlement costs.

Unfortunately, very few lenders provide this information on their web sites. Among those that do are Upfront Mortgage Lenders (UMLs), which are listed here. UMLs must provide this information in order to be certified.

As a source of no-cost loans, UMLs have advantages and disadvantages relative to B of A. UMLs provide on-line pricing for a wider range of products, and they provide complete pricing data on adjustable rate mortgages on-line, which B of A does not. On the other hand, B of A pays third party fees as well as its own, whereas UMLs only guarantee their own fees. Third party fees are estimates, honest estimates but still estimates.

NOTE: If you expect to have the mortgage 5 years or longer, you don’t want a no-cost mortgage unless you are desperately short of cash. If you have the cash, it pays to buy down the interest rate by paying points rather than the reverse. This calls for a revision of your shopping strategy, from finding the lowest no-cost rate to finding the lowest cost at a specified rate below the no-cost rate.

For example, if a 30-year FRM with no cost is available at 6%, set 5.5% as your shopping rate and find the lowest cost at that rate. With B of A, it will be the points charged on the 5.5% loan, which may or may not be available on-line. With UMLs, it will be the sum of lender and third party charges at 5.5%, which will be available on-line.

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