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Is No Cost Truly Zero Cost?

Posted December 30, 2008 by Kate Dickman

What the no cost refinance loan hides from those interested to grab the offer.

What’s not to like about no cost mortgage refinancing? A lot. Though there are preliminary benefits that include no prepayment penalties and other out-of-pocket expenses, refinancing applicants need to know that there are costs kept hidden until subsequent discussions with their lender. In today’s economy, nothing is definitely given for free.

No cost loans are so named because the lender would have to package the closing costs to a different payment scheme thus raising the size of your mortgage. To put it simply, you’d still pay for the other costs but at later dates. It targets typical homeowners who would want to convert their adjustable rate mortgage (ARM) to a restructured ARM or a new fixed rate mortgage. Those who would want to shorten their terms may also avail of the offer.

So how do these banks and lenders turn their marketing scheme into the same old story? The most common way is to strike a higher interest rate after explicit talks about absolute no upfront fees with the borrower. In this way, they can recover the closing costs that they would eliminate first. Another scheme is one where the mortgage provider will pay the credit report, lawyer fees, appraisal and even the courier but with a certain catch – borrowers would have to shoulder the costs of appraisal and credit report first before it will be refunded. Prepaid, escrow and lender fees are obviously not included as this is part of borrower’s personal expenses already. If the loan isn’t granted, then there’s no possibility that the said expenses will be returned.

Another practice is through adjusting the yield spread premium. The YSP is the payment to the broker who sold you the interest rate that is higher than the lowest rate that you have qualified for. If the lender sees an opportunity by which the costs can be recouped, simply adding a few points to the YSP can bloat your initial no cost computation. It’s that easy.

So you may wonder if this type of loan is still applicable in today’s credit situation. If you are in the habit of refinancing your mortgage again and again (though we can agree with Audrey Forshey’s top 9 learned lesson about the guarantee of repeat approvals), no cost loans are a viable option. However, if you find the additional costs that will still be carried over to be relatively expensive, we suggest you keep away from your lender’s no cost offer.
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