September 4, 2007
This article examines the claim that Bank of America’s new no-fee
program for house purchasers, under which lender and third party fees
are absorbed by the bank, is not novel because all lenders offer no-cost
loans. The claim has little validity, because most borrowers don't know
how to "roll their own" no-cost loan, and even if they do, other lenders
do not guarantee their quoted costs. An exception is Upfront Mortgage
Lenders, who do guarantee their costs, though not those of third
parties.
The Bank of America Mortgage
In a recent article I examined Bank of America’s new no-fee program for
house purchasers, under which lender and third party fees are absorbed
by the bank. (See
NoFeeMortgagePlus: Is Bank of America a White Knight?) On a
fixed-rate mortgage, the borrower pays the interest rate and points, and
that’s it. Price shopping would be so much easier, I mused, if all
lenders did the same.
A spokesman for another large lender responded to that article by
claiming that other lenders do offer the same product, they just give it
a different name; they call it a "no-cost mortgage".
Other No-Cost Mortgages
I will explain what he means with an over-simplified example. A lender
who absorbs all costs in its rate and points must mark up the price
accordingly. For example, if B of A is prepared to absorb $3,000 of
costs including third party charges to acquire a $300,000 loan at 6%, it
will price a no-fee loan at 6% and 0 points.
Now consider Lender X offering the same loan, and faced with the same
$3,000 in costs except that the costs are billed to the borrower. This
lender offers 6% at -1 point, which is a rebate to the borrower. The
borrower selecting the 6% mortgage on which the rebate just covers the
$3,000 has a no-cost mortgage from X that appears identical to that of B
of A’s.
In other words, the borrower from B of A pays 6% and nothing else. The
borrower from X pays 6% plus $3,000 in fees but receives a $3,000 rebate
from X.
Not All No-Cost Mortgages Are Alike
But note a critical difference. The $3,000 charged the borrower by X is
probably not guaranteed. A few lenders guarantee their own fees (see
below), even fewer guarantee third party fees. All the rest provide
estimates, which sometimes have a funny way of escalating as loans move
toward closing. So the borrower dealing with X might end up with a
rebate worth $3,000 and be billed for $4,000 in costs. That can’t happen
with the B of A mortgage.
Most borrowers are not aware of the no-cost option from lenders other
than B of A. The loan officers and mortgage brokers with whom they deal
are unlikely to volunteer the information because no-cost loans are
easier to comparison shop. If the borrower requests a no-cost quote,
they will comply, but the quotes are based on cost estimates that can be
far off the mark.
Finding a No-Cost Mortgage On-Line
Borrowers can roll their own no-cost mortgage on-line. They do this by
selecting an interest rate that carries a rebate large enough to cover
the settlement costs. This requires that they have access to the
complete range of rate/point combinations offered by the lender, as well
as the settlement costs.
Unfortunately, very few lenders provide this information on their web
sites. Among those that do are Upfront Mortgage Lenders (UMLs), which
are listed
here. UMLs must provide this information in order to be
certified.
As a source of no-cost loans, UMLs have advantages and disadvantages
relative to B of A. UMLs provide on-line pricing for a wider range of
products, and they provide complete pricing data on adjustable rate
mortgages on-line, which B of A does not. On the other hand, B of A pays
third party fees as well as its own, whereas UMLs only guarantee their
own fees. Third party fees are estimates, honest estimates but still
estimates.
NOTE: If you expect to have the mortgage 5 years or longer, you don’t
want a no-cost mortgage unless you are desperately short of cash. If you
have the cash, it pays to buy down the interest rate by paying points
rather than the reverse. This calls for a revision of your shopping
strategy, from finding the lowest no-cost rate to finding the lowest
cost at a specified rate below the no-cost rate.
For example, if a 30-year FRM with no cost is available at 6%, set 5.5%
as your shopping rate and find the lowest cost at that rate. With B of
A, it will be the points charged on the 5.5% loan, which may or may not
be available on-line. With UMLs, it will be the sum of lender and third
party charges at 5.5%, which will be available on-line.