to the conventional wisdom of waiting for the rates
to drop 2% before refinancing?
You have a 30-year fixed loan at 8.5%. A loan officer
calls you up and says they can refinance you to a rate
of 8.0% with no points and no fees whatsoever.
What a dream come true! No appraisal fees, no title
fees and not even any junk fees! Is this a deal too
good to pass up? How can a bank and broker do this?
Doesn't someone have to pay? Whose money is being used
to pay these closing costs?
No––this is not a scam.
Thousands of homeowners have refinanced using a zero-point/zero-fee
loan. Some refinanced multiple times, riding rates all
the way down the curve in 1992, 1993 and, more recently,
in 1996. Some homeowners used zero-point/zero-fee adjustable
loans to refinance and get a new teaser rate every year.
The way this works is based on rebate pricing, sometimes
also known as yield-spread pricing, and sometimes known
as a service-release premium. The basic idea is that
you pay a higher rate in exchange for cash up front,
which is then used to pay the closing costs. You will
pay a higher monthly payment––so the money
is really coming from future payments that you will
You can also think of this as negative points! For example,
a 30-year fixed loan may be available at a retail price
8.0% with 2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points
On a $200,000 loan, the loan officer can offer you 8.75%
with a cost of -1 point, which is a $2,000 credit towards
your closing costs. A mortgage broker can use rebate
pricing to pay for your closing costs and keep the balance
of the rebate as profit.
What are the benefits
of a zero-point/zero-fee loan?
The main benefit is that you have no out-of-pocket costs.
As a result, if the rates drop in the future, you could
refinance again even for a small drop in rates. So if
you refinanced on the zero-point/zero-fee loan to get
a rate of 8.75% and if the rates drop 1/2%, you can
refinance again to 8.25%. On the other hand, if you
refinanced by paying 1 point and got a rate of 8.25%,
it may not make sense to refinance again. Now, if the
rates drop another 1/2%, a zero-point/zero-fee loan
can drop your rate to 7.75%, whereas if you paid points,
you may have to do a break-even analysis to decide if
refinancing will save you money.
The zero-point/zero-fee loan eliminates the need to
do a break-even analysis since there is no up-front
expense that needs to be recovered. It also is a great
way to take advantage of falling rates.
Some consumers have used zero-point/zero-fee loans on
adjustable loans to refinance their adjustables every
year and pay a very low teaser rate.
What are the disadvantages
of a zero-point/zero-fee loan?
The main disadvantage is that you are paying a higher
rate than you would be paying if you had paid points
and closing costs. If you keep the loan for long enough,
you will pay more––since you have higher
mortgage payments. In the scenario where you plan to
stay in the house for more than 5 years, and if rates
never drop for you to refinance, you could wind up paying
more money. If, on the other hand, you plan to stay
at a property for just 2-3 years, there really is no
disadvantage of a zero-point/zero-fee loan.
Whose money is it?
Since you are being paid "cash" up-front in
exchange for a higher rate, it really is your own money
that will be paid in the future through higher payments.
Investors who fund these loans hope that you will keep
the loans for long enough to recoup their up-front investment.
If you refinance the loans early, both the servicer
and the investor could lose money.
To summarize, zero-point/zero-fee loans in many cases
are good deals. Make sure, however, that the lender
pays for your closing costs from rebate points and NOT
by increasing your loan amount. So if your old loan
amount was $150,000, your new loan amount should also
be $150,000. You may have to come up with some money
at closing for recurring costs (taxes, insurance, and
interest), but you would have to pay for these whether
you refinanced or not.
Zero-point/zero-fee loans are especially attractive
when rates are declining or when you plan to sell your
house in less than 2-3 years.
Zero-point/zero-fee loans may not be around forever.
Lenders have discussed adding a pre-payment penalty
to such loans, however few lenders have taken steps
to implement such a measure.