Richmond Times-Dispatch Weekend
Finding Hidden Costs When Closing
Question: We want to refinance with a no-closing cost loan. Friends tell us this may not be a good idea because there can be hidden costs. Can you explain how these loans work?
Answer: With a no-closing cost loan a lender will eliminate some or all closing costs in exchange for a higher rate. There’s nothing hidden about it. No one said the loan was cost-free and no one should think that it is. Instead, with a no-closing cost mortgage the expense of the transaction is shifted from closing to the interest rate. This raises a question: What’s the actual cost of the loan? There are so many numbers in motion that it may be hard to understand but here are several measures to consider.
First, when getting loan quotes from lenders tell them you first want to know the “par” rate – that’s the rate without any points (loan discount fees).
Second, read the whole offer, not just the headline. For instance, a solicitation might feature an extremely low rate and with it a greatly-reduced monthly payment. However, if the required points (loan discount fees) equal 3.5% of the loan amount the borrower might do better elsewhere. For a $250,000 mortgage that 3.5% charge is equal to $8,750.
Third, the annual percentage rate – the APR – can be confusing. For example, if you borrow $200,000 at 2.75% with two points the APR is 2.906% over 30 years according to one calculator. But, will you have the loan for 30 years? Not likely. If the loan is outstanding 10 years the effective APR rises to 3.17%.
Fourth, be sure to read the official Loan Estimate (LE) form that lenders must provide. You’ll see the interest rate on page one. The APR and five-year costs are on page three.
As interest rates have declined lenders have looked toward fee income to enhance bottom-line results. According to Freddie Mac mortgage rates averaged 3.94% in 2019 but fell to 3.11% in 2020. Meanwhile, profits per loan increased. According to the Mortgage Bankers Association (MBA), “independent mortgage banks (IMBs) and mortgage subsidiaries of chartered banks reported a net gain of $5,535 on each loan they originated in the third quarter of 2020.” In the third quarter of 2019 the net gain per loan was $1,924.
Lenders have the right to negotiate and so do borrowers. In the 2020 environment – when lenders were over-run with loan applications – it was a lender’s market, but that doesn’t mean borrowers couldn’t do well. The keys to low rates in 2021 – as always – are good credit, steady income, savings, little debt, and shopping around for the best opportunity.