Mortgage FAQ

3. Should I pay points? Does a 0 point/0 fee loan really exist?

If you are trying to decide whether or not you should pay points, the best way thing to do is compare costs with a break-even analysis. This is done as follows:

1. Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000.
2. Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month
3. Divide the cost of the points by the monthly savings. This will give you the number of months it will take to break even. In the above example, this number is 40 months. If you plan to keep the house for more than the number of months it will take to break even, it makes sense to pay points; otherwise, it does not.
4. Keep in mind that the calculation above does not take into account the tax advantages of points. The points you pay are tax-deductible, so when you are buying the house you will save some money immediately. On the other hand, when you get a lower payment, your tax deduction will decrease. Calculating the break-even time is a little more difficult because you must take taxes into account. In a purchase, taxes definitely reduce the break-even time. However, in a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the loan. This means fewer tax benefits or none at all, so there is little or no effect on the time to break even.

If none of the above makes sense, use this simple rule of thumb: If you plan to live in your home for less than 3 years, you should not pay points. If you plan to live in your home for more than 5 years, you should pay 1 to 2 points. If you plan to live in your home for between 3 and 5 years, paying points or not will not make a significant difference.

Zero-Point/Zero-Fee Loans

Whatever happened to the conventional wisdom of waiting for the rates to drop 2% before refinancing?

Imagine you have a 30-year fixed loan at 8.5%, and a loan officer calls you up and says that they can refinance you to a rate of 8.0%--no points and no fees whatsoever.

Sound perfect, right? No appraisal fees, no title fees, no hidden fees. Is this a deal too good to pass up, or too good to be true? How can a bank and broker do this? Someone has to pay, right? 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 may have refinanced multiple times as rates went down in 1992, 1993 and 1996. Some homeowners might have used zero-point/zero-fee adjustable loans to refinance, getting a new "teaser" rate every year.

This works through rebate pricing, also known as yield-spread pricing, or a service-release premium. Basically, you pay a higher rate in exchange for cash up front, which is then used to pay the closing costs. You end up paying a higher monthly payment--so the money is really coming from future payments that you will make.

You could also think of this as a negative points system. For example, a 30-year fixed loan might be available for a retail price of:

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 could offer you a rate of 8.75% with a cost of -1 point, leaving a $2,000 credit towards your closing costs. A mortgage broker could use rebate pricing to pay for your closing costs, while keeping the balance of the rebate as profit.

What are the benefits of a zero-point/zero-fee loan?

The main benefit to you is no out-of-pocket costs. This means that if the rates drop in the future, even a small amount, you could refinance again. If you refinanced on the zero-point/zero-fee loan to get a rate of 8.75%, and the rates drop 1/2%, you could refinance again to 8.25%. However, if you refinanced by paying 1 point and got a rate of 8.25%, it might not make sense to refinance again. But, if the rates drop another 1/2%, a zero-point/zero-fee loan could drop your rate to 7.75%. But keep in mind that if you paid points, you may have to do a break-even analysis to decide if refinancing again will still 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. This makes it a great way to take advantage of falling interest rates.

Some consumers use zero-point/zero-fee loans on adjustable loans to refinance their adjustables every year, paying a very low "teaser" rate each time.

What are the disadvantages of a zero-point/zero-fee loan?

The major disadvantage is that you will be paying a higher rate than you would be paying if you paid the points and closing costs. If you keep the loan for long enough, you will end up paying more, because your mortgage payments are higher. If you plan to live in the house for more than 5 years, provided rates never drop enough for you to refinance, you could actually end up paying more money. However, if you plan to live in the house for just 2-3 years, there really are not any disadvantages to a zero-point/zero-fee loan.

Whose money is it?

Since you are getting "cash" up-front in exchange for a higher rate, it actually is your own money that you end up paying in the future through higher payments. Investors fund these loans in the hopes that you will keep the loans long enough for them to recoup their up-front investment. If you refinance the loans early, both the servicer and the investor stand to lose money.

To summarize, a zero-point/zero-fee loan can provide a good, money-saving deal. However, in order to truly save money, you need to make sure that the lender is paying for your closing costs from rebate points and NOT by increasing your loan amount. If your old loan amount was $150,000, your new loan amount should still be $150,000. You may have to come up with some money at closing for recurring costs that are not covered (taxes, insurance, and interest), but you would have to pay for these whether or not you were refinancing.

Zero-point/zero-fee loans are especially attractive when interest rates are declining or when you plan to sell your house in less than 3 years.

The future of zero-point/zero-fee loans is unsure. Lenders have discussed adding a pre-payment penalty to such loans, but as of yet, very few lenders have actually implemented additional fees or penalties.

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