Minimizing the Upfront Costs of a Mortgage:
What Borrowers Ought to Know
What Borrowers Ought to Know
Mortgage borrowers have some control over the
amount of cash they must produce at the closing table.
Minimizing the amount, however, may or may not be in their
Interest Rates and Lender
Borrowers can control the amount of cash they are
required to produce at closing when they select the
combination of interest rate and points from among those
offered by their lender. For example, a borrower shopping a
$300,000 30-year fixed-rate loan on my site on December 8
was offered the following interest rate/point options: 3.25%
and $9298, 3.50% and $4125, 3.75% and -$1160, 4% and -$4875,
4.25% and -$8625, 4.50% and -$11,625, 4.75% and -$14,625,
and 5% and -$17,625.
Points are an upfront charge paid to the lender
while negative points are rebates credited to the borrower.
Rebates can be used only to pay settlement costs.
Factors Bearing on the Decision
A major factor is the borrower’s expectation
regarding how long the mortgage will be in force. Because a
rebate mortgage carries a higher interest rate, the cost
mounts over time. Borrowers with long time horizons will do
better paying points in order to get a lower interest rate,
provided they have the needed cash.
Borrowers with relatively short time horizons, say
7 years or less, will save more on upfront costs by taking a
rebate than they will lose from the higher interest rate.
The two approaches such a borrower can use are to seek
either a “no-cost mortgage” or a “no-charge mortgage.” The
difference is that the latter uses a larger rebate to cover
charges that are not covered by the no-cost mortgage.
The term “no-cost” is something of a misnomer. The
costs that the borrower does not pay are those that
otherwise would be paid to the lender -- points and
origination fees -- plus charges of third parties that
benefit the lender, such as lenders’ title insurance or
appraisal. Borrowers taking no-cost loans do pay per diem
interest, tax and insurance escrows, homeowners insurance,
owners title insurance if they want it,
and transfer taxes if any. A more accurate designation would
be a “no lender charges mortgage”.
The no-charge mortgage is for borrowers who don’t
want to make any cash outlays at all at closing. If the
rebate is large enough, it will cover all the items
enumerated above that are not covered by a no-cost mortgage.
The only charge imposed on the borrower that cannot be
covered by a lender rebate is the required down payment.
The danger on a no-charge mortgage is not that the
rebate won’t be large enough but that it will be too large.
A rebate in excess of cost is lost – the borrower cannot
draw it in cash. Borrowers opting for a rebate need to know
the charges that the rebate will cover so that they won’t
pay for a rebate they can’t use.
Arranging a No-Charge Mortgage
A borrower can’t shop for a no-charge mortgage
because there is no way for a lender to know in advance the
charges not covered by a no-cost mortgage. The borrower has
to select the lender in some other way, and then arrange for
a no-charge mortgage.
The easy way to do this is to select the lender
recommended by a Realtor or another trustworthy source,
apply for the loan, and ask the lender what interest rate
you will have to pay to obtain a no-charge deal. That
invites the lender to over-charge you, but maybe he won’t.
The harder but safer way to do it is to select the
lender based on rebate comparisons at an interest rate you
specify. Submit an application to the lender you select,
then use the GFE you receive to estimate your total charges.
With your estimate in hand, inform the lender that you want
to lock the price and to forward the complete set of pricing
options. From the price sheet, you select the rate/rebate
combination that will just cover your charges, erring on the
side of insufficient rebate.
Borrowers taking a no-charge mortgage without a roadmap that will take them out of their mortgage within 7 years or so will pay a steep price for their shortsightedness.