Why in the world would anyone want to pay $10,000 to refinance; especially when there are all kinds of lenders advertising “free” loans? Well, because the idea of a “free loan” is a little misleading and lenders use this to their advantage when advertising these programs. If the idea of paying closing costs makes you cringe, you need to read this.
No Such Thing As A Free Lunch
Ever heard the saying, “There’s no such thing as a free lunch?” Well there’s no such thing as a free mortgage either; think about it, there’s a lot of work that brokers and banks put in to helping you refinance. Do you think these people are working for free? They’re definitely not. So, what is a “free loan” really and how does it differ from a loan with closing costs?
Scenario 1: Let me give you a little info on how I price a loan with a lender to help you understand this. Lenders allow borrowers to pay points upfront in exchange for a lower interest rate; the opposite holds true as well: lenders will pay a rebate in exchange for a higher interest rate. So, let’s say you want to refinance your house and you’re willing to buy the rate to the “floor” (the lowest rate the lender has available); such a refinance can cost a lot of money upfront. As of today, for example, a borrower with a loan amount of $600,000 can get an interest rate of 5.75% at a cost of 1.6 points, or about $9,600 – not including other closing costs, which can run another $9,500. As I write this I can just picture you shaking your head saying, “There’s no way I would pay almost $20,000 to refinance my house!” No problem, let’s see what kind of rate we can get “for free”.
Scenario 2: As of today (remember, rates change every day), that same borrower can get a loan with absolutely no closing costs at a rate of about 6.75%. How are there no closing costs? Because in exchange for accepting a higher interest rate, the lender will pay a rebate of about 1.5 points (1.5% of the loan amount), or $9,000. That $9,000 will go to pay for your closing costs so you don’t have to.
The Free Loan Myth
So, the question is, “Is the loan really free?” Well I’ve already told you no, but let me prove it to you.
In scenario 1 above, your monthly payments would be around $3,600 a month. Scenario 2 would give you payments of around $3,900 a month because of the higher interest rate. So, why would anyone pay $20,000 to save $300 a month? When the cost of the buy-down pays for itself before you refinance again. If you take the cost of the buy-down, $20,000, and divide by the monthly savings of $300, you find that it will take about 67 months (5 years, 7 months) to break even. Obviously if you’re only going to be in the house for another 3 years, the buy-down isn’t worth the cost, but what if you are refinancing into a 30 year fixed and don’t have any plans to move in the future? In this case, the buy-down saves you $88,000 over the life of the loan and gives you a lower monthly payment.
So, next time you see one of those TV commercials advertising a no closing cost loan, remember, there’s no such thing as a free lunch. A good mortgage broker will be able to calculate the best option for you based on your goals.
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3 responses so far ↓
1 L1BERTAR1AN // Apr 25, 2007 at 5:05 pm
That is a very useful article. I have never bought a house/condo and really don’t want to because I am scared to death of getting eaten alive by a mortgage broker.
2 John // May 1, 2007 at 5:15 pm
A lot of people feel that way. Mortgage brokers are being viewed, more and more, as scandalous salespeople who are only interested in getting as much money from you as possible.
The reason for that is most borrowers aren’t familiar with how mortgage lending works, so when they get connected with a shady broker, they have no other information to go on other than what that broker’s telling them. Because of that lack of knowledge it’s easy for shady brokers to take advantage of you. It’s a situation where, unfortunately, a lot of people see this industry as a way to get rich quick and they’re willing to do anything to make that money…these brokers make it more difficult for the rest of us.
Listen, just like any other business, you’re not going to succeed unless you give the customer what he/she wants. These guys may make some quick cash, but I think a lot of them are going to end up in jail as a result of this subprime crackdown we’re having.
Ultimately, a good, trustworthy mortgage broker is worth his weight in gold. Don’t let your fear of being taken advantage of keep you from purchasing. Purchasing a home is your first step toward getting ahead financially. Education is the best medicine for this virus – if you know what to expect, it’s going to impossible for some shady broker to pull the wool over your eyes.
3 avnn // Apr 23, 2009 at 10:35 am
Easier way out !
Listen and ask really studpid questions .
truth comes out easily.
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