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No Cost?
For six years there has been an ad in some nearby newspaper trumpeting "No Cost Refinance!"
This misnomer has been a boon to many borrowers, and even the free lunch bunch has been aware that there is a cost of some kind.
The No Cost "refi" has peculiar origins, is difficult to price-compare, and has a use in purchase money loans which is so extreme that most borrowers flinch away from a good deal.
The No Cost refi had an immediate predecessor, the term for which is now a mangled synonym for the No Coster: the Streamline refinance. The two are not the same.
In 1986, as residential real estate in the oil patch was in terrible trouble, the Federal Housing Administration and the Veteran's Administration were in equally desperate straits. As the FHA and VA are the guarantors of the lowest down payment loans and the most liberal underwriting, their foreclosure problem threatened their futures (to say nothing of the taxpayers' wallets).
One particular aspect of foreclosure defied normal solutions. Millions of people had taken out VA and FHA loans from 1979-85 when interest rates were 12-16%, and could not refinance because the property value had fallen below the loan amount. The most unfortunate had "Graduated Payment" loans, meaning an early form of negative amortization, where deficit equity was a planned event.
With astounding insight for a pair of federal agencies, the FHA and VA announced the Streamline refinance. If your payments were current, and you had enough cash to close, you could refinance no matter what had happened to the property value. This program allowed many people to knock five percent off their interest rate (more than a 30% reduction in the house payment), and kept them form walking away from home and mortgage.
Soon after the Streamline start, it was clear that many people were so close to the line that they did not have the one or two grand necessary to close the refi.
No Cost was born.
It was a simple idea, really, and one which had been available to consumers for years -- it had seemed to weird to use. Raise the interest rate, and throw off enough cash for refiers to close. This rate-into-money works for all loan types, not just FHA and VA.
By the inexorable mathematics of mortgages, each .125% in rate (one eighth of a percent) is equal to about .625% of the loan amount in cash. Since FHA and VA loans to this day are available only in half percent increments of rate, each markup in rate from the current market would generate about 2.50% of the loan amount in cash (.50% in rate = four eighths; 4 x .625 = 2.50% of the loan amount in greenbacks).
If you mark up your rate, and run some more math, you will find that the break-even point for cash today versus a higher rate in the future works out to about eight years. Most people aren't ahead of their bank for eight minutes, let alone eight years.
When shopping for a No Cost refi, keep in mind the real cash cost of the deal. These costs vary by loan type, property, and hardly at all by loan size. Refi costs tend to be fixed ones irrespective of the loan amount: it costs the same dollars to get a $25,000 loan into a Ginnie Mae as it does a $115,000 one.
Once you have gotten no more than two good faith estimates of full cost, you pay 'em refinances, you'll know how many dollars you are trying to convert into rate. By our math, above, on a $100,000 loan, each .125% in rate pays about $625 in cost. On a $30,000 loan it only pays $188, hence the prevalence of higher fees for smaller loans.
If you compare different rates offered on No Cost terms, you can figure out if you are being skinned by a banker yanking the rate unnecessarily high.
In the modern era, this same set of mathematics has led to "zero and zero" purchase money loan pricing, and the old, automatic, "origination fee" is about to disappear.
If you are buying a house, and can stand to have a higher rate than your neighbor, no cost purchases are as easy to arrange as no cost refis.
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