One of the more common requests I get from borrowers shopping for a mortgage is for a “no points” loan. “Points” represent fees paid to buy down the mortgage rate, with each point equaling one percent of the loan amount. Typically, paying a point should reduce the mortgage interest rate by 1/4 percent. (For more information comparing points versus no points mortgages, please see my January 19, 2010 blog.) While there is a general perception that paying points is bad, doing so can offer clear advantages and many borrowers would benefit from significant savings over the life of their loan. Nonetheless, a no points mortgage does reduce one’s closing costs. But there is another option that lowers costs even further: the “no cost” loan.
With a no cost loan, the borrower agrees to take a slightly higher interest rate on their mortgage. The premium the lender is willing to pay for this higher rate is then used to offset the loan’s non-recurring closing costs, including processing, lender, appraisal, title, and escrow fees. While this may seem counter intuitive since everyone is hunting for the lowest rate, there are many occasions when taking a slightly higher rate to reduce costs makes good sense. The non-recurring closing costs on a purchase can easily reach $8,000 to $10,000 in high cost areas such as Marin and San Francisco. And then a buyer will likely have several thousand dollars more in closing costs for items such as mortgage interest, taxes, and their new home’s annual hazard insurance premium. If planning to keep the home for just a few years, it would be a bargain to take a slightly higher rate to absorb the majority of their closing costs. For borrowers with more limited funds, this option could prove a windfall.
As an example, a high balance conforming 30-year fixed loan of $729,750 might have an interest rate of 4.5% at no points. The monthly principal and interest payment on this mortgage would be $3698. At 4.75% on a no cost option, the borrower could receive a credit of $8,000 to $10,000 (depending on the yield spread when locked) to offset the majority of their closing costs. The payment on this higher rate would be around $3,807, an increase of roughly $109 per month. So, if the borrower planned on keeping their home for the short term, the no points mortgage would be their best option.
For a mortgage refinance, the no cost option is an equally valuable tool. Closing costs on refinances are considerably lower and the rate increase on the no cost loan is often a mere 1/8 percent. Since the borrower mitigates $3,000 to $4,000 in non-recurring costs, they are in a better position to refinance later on should rates drop further.
Nicholas Ballard is both a mortgage broker and banker specialized in the residential Marin market. For assistance, please call or e-mail:
Nicholas Ballard: 415-526-1941; firstname.lastname@example.org
Real Estate Financing
CA Dept. of Real Estate #01356374
California Mortgage Advisors, Inc.
CA Dept. of Real Estate #01170868
Redwood Highway, San Rafael 94903