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Home Mortgage

January 2007
Home Mortgage

During the past several years long-term fixed interest rates have somewhat unnaturally tended to copy the falling leaves soon after Labor Day. In the wake of this phenomenon, some in the Mortgage Bazaar have also tended to escalate their bombardment of the public with the so-called No Closing Costs Loan (NCCL) to purchase a house or to refinance an existing mortgage.

This creative, relentless, multimedia, marketing campaign has succeeded in generating great excitement, obvious confusion, and some disappointment among the consumers when they discover that catching a falling rate, cost-free, is as real as catching a falling star.

The purpose of this brief expos� is to dissect the anatomy of usual and customary fees involved in making a new residential loan and thereby exploding the myth of an NCCL. Assistance from a generic Good Faith Estimate of Settlement or Closing Costs (GFE) has been enlisted to better illustrate this exercise. It should be evident from the GFE for a $200,000 refinancing scenario at 5.75% fixed rate for thirty years, that a new mortgage always costs money. The various parties providing different services from application to closing must be paid at the closing. Some fees such as appraisal and credit reports have to be paid prior to the closing at the time of application—unless a lender postpones this until the closing (but may never get paid if the loan does not close for any reason).

These expenses do not suddenly disappear with the wave of a magic wand or by chanting some esoteric verses or doing a mystical dance invoking divine intervention. Someone has to pay and this person, inevitably, is the consumer who pays directly or indirectly, sooner or later.

In addition to the closing cost of $4,860 and prepaid expenses of $2,395 appearing in this example, most lenders require an escrow account consisting of reserves for property tax and hazard insurance whether purchasing or refinancing—when the loan to value (LTV) is above 80% of purchase price or appraised value, respectively. Although some of the fees appearing on the GFE without an asterisk (*) may be negotiable, the rest are pretty much non-negotiable.

Basically there are only three ways in which a loan can be paid for: 1) from the borrower's pocket; 2) by adding the cost to the loan amount thereby increasing the balance; and 3) accepting a higher than the going rate in return for the lender paying the costs. This third option is what the mortgage industry's creative marketers have been publicizing and glorifying as the NCCL. However, because of the higher rate and other factors discussed earlier, there is no true NCCL. It is just a mirage.

No matter which of the three paths a borrower chooses, there are several hurdles to be cleared. The first and foremost checkpoint is that of creditworthiness. If that is satisfactory, the next will be the financial fitness (Income/Employment/Assets) roadblock to be negotiated in a manner to qualify for the best rate. Another determinant of the evolving shape of the loan will be the appraised value to establish loan-to-value (LTV) as mortgage insurance (MI/PMI) kicks in on LTV above 80%. Additionally the legal status and type of visa will affect the total picture. Finally, prepaid expenses, one month's accrued interest on the loan to be refinanced, and escrows have to be addressed.

For the hypothetical loan presented in the GFE to be eligible for refinancing without out-of-pocket expenses, the existing rate has to be around 1% higher than the market rate, and the loan amount must be over $200,000, and all the checkpoints mentioned earlier should be successfully navigated to accomplish the lender-paid, higher-than-market rate but lower-than-existing rate refinancing journey.

Thankfully, those who refinance can borrow without sorrow as there is a mandatory three-day right of rescission during which the entire transaction can be canceled by the borrower for any reason .

If this writer unearths a magic formula to make the closing costs evaporate he will surely share it with Khabar readers.


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