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Zero Points and Zero Fee Loans
Whatever happened 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! How can a bank and broker do this? Doesn't someone have to pay? Whose money is being used to pay these closing costs? What are the benefits of a zero-point/zero-fee loan? What are the disadvantages?
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.
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.
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 breakeven 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. Zero-point/zero-fee loans in many cases are good deals.
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.
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 be wind up paying more money. On the other hand, if you plan to stay at a property for just 2-3 years, there really is no disadvantage of a zero-point/zero-fee loan.
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