The
mechanics
Rebate pricing (yield spread
pricing, service-release
premium) makes zero-point/fee loans possible.
Simply put, you pay a higher-than-market
interest rate in exchange for cash. The cash
is used to pay your closing costs. Here is
a hypothetical example of rate/points combinations.
The negative points are rebates. One point
is 1 percent of the loan amount.
6.25%, You
Pay 2 points
6.75%, You
Pay 1 point
7.00%, You
Pay 0 points
7.50%, - The Lender receives- 1 point (1%
x loan amount)
8.00% - The Lender receives - 2 points (2%
x loan amount)
On
a $100,000 loan, you can pay 8 percent
interest and receive two points, ($2,000)
which you can use to pay your closing costs.
What are the benefits
of a zero-point/fee loan?
You
can lower your monthly payment with no
out-of-pocket expenses. In the short-run,
you can save money. There may be some
recurring costs collected from you
at closing, but you'd pay these costs if
you didn't refinance. They are not
a cost of the transaction. Recurring costs
include property taxes, insurance and pre-paid
mortgage interest.
What
are the disadvantages of a zero-point/fee
loan?
The obvious
disadvantage is that you're paying a
higher rate in order go obtain the rebate. If
you pay closing costs from your personal
funds, you receive a lower interest rate.
If you keep the loan long enough, (approximately two
to three years) you'll pay more than
if you had paid points, closing costs and
received a lower rate.
Not
quite as obvious is something that can
happen each time you refinance: you
extend the time you have a mortgage. Suppose
you purchase a home and obtain a $100,000,
8 percent, 30-year, fixed-rate loan. After
three years your loan balance is $97,750.
You get a new, $97,750, 7.5 percent, 30-year,
zero-cost/fee loan. After another three
years your loan balance is $95,330. You
obtain a new, $95,330, 7 percent, 30-year,
zero-cost/fee loan. You keep the 7 percent loan
and pay it off over 30 years.
This scenario
may seem unlikely, but many people refinanced
this way more than once in the 90s.
In this situation, refinancing cost
more than holding the original, 30-year,
8 percent mortgage. This scenario
will cost more because you twice exchanged
a 27-year mortgage for a 30-year mortgage. Your
home will be mortgaged for thirty-six
years instead of thirty.
Zero-point/fee loans can
be advantageous. Make sure the rebate covers your
closing costs. Don't increase your new loan
amount by adding your closing costs to it.
For example if your old loan amount was $100,00,
your new loan amount should be $100,000.
Zero-point/fee loans are especially attractive
when rates are declining and you plan
to sell your home in fewer than two
to three years.
More on this issue.
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Refinance Sections
