I posted last week that I'm refinancing my mortgage. Now I can add more details. I lowered the interest rate on my 15-year fixed rate mortgage by 0.25% from 5.125% to 4.875% using a "no cost" refi. All closing cost will be covered by the lender. In exchange, my rate is higher than what it could've been. If I chose to pay the closing costs, I could've got 4.625%.
I've done this quite a few times since I bought my house. Every time the interest rate drops, I exercise the built-in put option on the mortgage and do a "no cost" refi. This way I make sure my interest rate is never more than 0.25% higher than the lowest rate. I call this "stepping down the ladder." The 0.25% number is the typical penalty on my loan amount for doing a "no cost" refi versus paying the closing cost.
I must make it clear that what I did worked for me, in the time period so far. It will not work for everybody. Nor will it work in all rate environment.
With a "no cost" refi, I don't pay any closing cost at the time of closing. My principal balance doesn't increase either. After the refi, I pay a lower interest rate than what I had before. I benefit from day one. It removes the biggest uncertainty for any refinancing decision making -- "Is it worth the closing cost?" As long as the interest rate is lower, it's worth it.
"No cost" refi is not really no cost in the strict sense. All parties involved in the refi still get paid. They are paid by the lender via a negative point. Similar to how paying a point buys down the interest rate, a negative point bumps up the rate from what it otherwise would be. For example this time I had a choice between
- pay $3,000 in closing cost and refi to 4.625%; OR
- pay nothing in closing cost and refi to 4.875%
If I choose "no cost" the lender pays the one-time closing cost up front and collects a higher interest over time. If I keep the mortgage past a break-even period, the lender becomes better off. If I don't keep the mortgage for long, I'm better off. Theoretically if I knew which refi will be my last one and I will keep that loan for a long time, I should choose to pay the closing cost. According to the mortgage refinance calculator 3a by The Mortgage Professor, my break-even period between my two choices this time is 9 years. Because I refinance aggressively and because the rate has been falling, I've never held a mortgage for that long. When I refi'd last time, I thought about paying the closing cost because the rate was already low. It only lasted two and half years. I had the same thought this time. In the end I still chose to leave my options open with a "no cost" refi. Let's see how long this one lasts.
For more info and pros and cons on "no cost" refi, please also read No-Cost Mortgages by The Mortgage Professor (link posted by Taylor Larimore in the Bogleheads forum. Thank you, Taylor.).
9 comments:
TBF, I am wondering how could you possbly get this rate with no points/no closing? That would get you below the wholesale. Rates do differ depending on the state, but we are talking almost a point here. Can you disclose the broker?
Rates fluctuate. I locked in my rate on 1/23/2008. The rates were low on that day. For example PenFed credit union's rate was 4.625% then. Today it's 5.000%.
It sounds like you are in the mortgage business. What do you think of my strategy overall?
Anon - I also locked the same day as tfb. I was shopping 30 year rates for a week. The perfect storm hit that day. The fed cut the rate 0.75 and the bond and stock market went wonky. I don't know enough about markets to explain why, but mortgage rates dipped very sharply very quickly and went back up the next day and into the next week.
PS - I got 5% on a 20 year fixed with many of the lender costs paid. Not all like tfb, however. Still, I'm cutting 8 years off my mortgage for $50 a month.
So you've extended your loan by three years when you went from a 15-year loan in 2005 to a 15 year loan in 2008?
I'm not sure I'd want to do that.
Am I missing something?
Grace,
If I follow the new amortization schedule after the refi, yes, my loan payoff date will be extended for 3 years. But I don't have to follow the new payment schedule. If I keep paying what I used to pay before the refi, which is higher than what the new required monthly payment will be, my loan will be paid off sooner than 12 years because my interest rate is lower and more of my payment will go toward principal. When you have a 15-year loan, it doesn't have to be 15 years. You can make it a 12-year loan, a 10-year loan or any shorter length you want by paying more than the required monthly payment.
tfb,
Does a rate with zero points usually mean that the lender pays ALL closing costs, or just the origination fee?
Brad - Zero point does *not* mean that the lender will pay ALL closing cost. There still can be various fees charged by both the lender and third parties.
tfb - so did you get all closing costs covered in your case? Was the $3000 you referred to in your post all of various lender and third party fees, or just the origination? Thanks for your prompt response!
Hi TBF,
Answering your question, as long as you are not falling for "bait and switch", your strategy is fine, assuming you are not planning on keeping your property for more than 5 years. Beware, there are a lot of schemers out there, all they have is a 1/4 point spread per hundred to work with and no points no closing costs is more enticing to them.
Another point - going from 30 to 15 - you are increasing your P+I, should you lose a job, this may be a problem, but that's kind of an obvious consideration
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