I’ve been following a step-down-the-ladder approach for mortgage refinancing. Whenever I can lower my rate for at least 0.25% with no closing cost (credit from the lender covers closing cost), I would do it because I have nothing to lose. Every time I do it, I save hundreds of dollars a year, every year.

The Fed purchased $1.25 trillion in mortgage-backed securities. The purchase has kept the mortgage rates low. When the life support is withdrawn, the rates won’t necessarily jump up immediately, but I don’t see how the rates will be lower without the support than with the support.

I’m going with the same lender I used last year: National Mortgage Alliance (NMA). I like NMA because their rates and fees are the best I can find for my loan. They also show a transparent trade-off between rates and fees on their website. For example, at the time I’m writing this, NMA shows these for a hypothetical $150k 30-year fixed loan for a home valued at $200k in Missouri:

It makes it very easy to compare against offers from other lenders. You either find the same rate and compare the fees or find a similar fee and compare the rates.

I locked my rate at 4.25% with no point and no closing cost for 15-year fixed. With the lessons I learned from last year, I was able to get the automated underwriting system to waive the appraisal. That will save a lot of time and some money.

The refi is scheduled to close by March 31. If it does, it will be one of the fastest closing I’ve ever had.

---
Software picked, likely related articles at The Finance Buff:

• Cost of Driving One Mile
• Mortgage Rates Back to April Lows
• I’m Refinancing My Mortgage

Andrew Kalotay Associates is a fixed income analytics and debt management advisory services company in New York. They sent me a special report they wrote for Mortgage Bankers Association, the industry trade group.

A Financial Analysis of Consumer Mortgage Decisions, Andrew J. Kalotay and Qi Fu

The 60-page report attempts to answer three common questions in getting a mortgage. Two of which are of interest to me.

1. How many points should you pay on your (fixed rate) mortgage? No point, 1 point, 2 points, or a no-cost loan with negative points?

Most of the calculators on the web, including ones created by The Mortgage Professor, use break-even analysis. They show you how long you will break even between different loans. Then they ask you “how long will you keep the house?” That’s actually the wrong question to ask. The correct question should be “how long will you keep the loan?” because you can refinance if the rate goes down.

The Kalotay and Fu paper takes a different approach. It applies “industrial strength” option pricing model to these loan decisions.

A mortgage loan in the U.S. is basically a callable bond. When a borrower gets a loan, the borrower issues a bond to the lender. The borrower is also free to call the bond at par at any time. The call option embedded in the bond has value. The value of the call option differs depending on the interest rate, interest rate volatility, and the remaining term of the loan.

Comparing different loans means comparing the APR for the loan payments, the upfront cost, and the value of the call option. Kalotay and Fu call it option-adjusted APR or APRPlus.

They created a mortgage points calculator for comparing APRPlus. I got some current quotes for a 30-year fixed rate loan from a lender and I calculated the regular APR and the APRPlus:

The 5% loan is a no-cost loan. There is little upfront cost, but it has the highest rate and the highest APR. The 4.5% loan has a high upfront cost with a low APR. After adjusting for the value of the call option, the option-adjusted APRs for all these loans are practically identical.

Even after adjusting for the value of the call option, I think it still biases toward the loan with a higher upfront cost, because the typical holding period for a 30-year loan is much shorter than 30 years even without refinancing.

2. Should you refinance now?

Kalotay and Fu apply the same option pricing framework to the mortgage refinancing decision. When you refinance to a lower rate, you also reduce the value of the embedded option in the loan. The cost savings from refinancing must be sufficient to cover the loss of the option value. This is the same decision framework corporate treasurers use when they decide when to call their bonds.

Because homeowners can’t easily calculate the value of the call option in their loan, Andrew Kalotay Associates developed a mortgage refinancing calculator for us. You enter the information about your current loan and the refinancing offer. The calculator will calculate a Kalotay Refi Score (the higher the better), together with a recommended action. You will get “Don’t Even Think About It!”, “Not Yet!”, “OK, But Not Optimal”, or “Go For It!”

For example, if someone has a $200k mortgage at 5.25% with 28 years to go, refinancing to a 5.0% loan with $2,000 closing cost will get a “Not Yet!”. Cutting down the closing cost to $1,500 will get a “OK, But Not Optimal”. If the closing cost can be reduced to $950 or less, the calculator will say “Go For It!”

I like these option-aware calculators. The mortgage rates are low once again. Try them and see if you should refinance. I already sent out an e-mail to the loan officer I used last time. When the rate hits my target, they will let me know.

---
Software picked, likely related articles at The Finance Buff:

• Mortgage Rates Back to April Lows
• "No Cost" Mortgage Refinance: Stepping Down the Ladder
• I’m Refinancing My Mortgage

I did the refi through National Mortgage Alliance (NMA), which is a division of a bank Georgia Banking Company (GBC). The name on my loan paperwork was “Georgia Banking Company dba National Mortgage Alliance.” Officially, I borrowed money from GBC. But at the time I locked my rate in April, six weeks before the refi was closed, I already knew that my loan would be sold to another bank right after it closed.

Let’s call this other bank Bank B. When I locked my rate with NMA, NMA also paired my loan with Bank B. The money, for all practical purpose, really came from Bank B. It was only routed through GBC/NMA temporarily. NMA earned the difference between what Bank B offered and what it offered to me.

This business model is actually very similar to that of a mortgage broker, with the exception that NMA’s name showed up on my loan paperwork, whereas a loan through a mortgage broker would have Bank B’s name on the loan paperwork.

I learned that this business model is called correspondent lending. The bank that deals with the borrowers on the front line is called a correspondent lender. They sometimes advertise themselves as a direct lender although they only make a loan if someone else buys it. A bank that provides short-term financing to the correspondent lender is called a warehouse lender. The short-term financing given to the correspondent lender is called a warehouse line. The bank that ultimately takes over the loan is called an investor.

This 30-minute video by Morgan at Blown Mortgage blog explains thoroughly what happens behind the scenes in correspondent lending:

Understanding Flow-based Correspondent Lending

It matched my experience perfectly. If you don’t have 30 minutes, here’s the presentation in PDF. Morgan also wrote an excellent post The Mortgage Broker vs. Mortgage Banker Argument which clears up many myths about mortgage brokers versus direct lenders.

---
Software picked, likely related articles at The Finance Buff:

• Signed Mortgage Refinance Documents
• Mortgage and Home Loan
• What Did the Appraisers Do Wrong?

The word "mortgage" is probably one of those most widely misused words that eventually the misnomer will trump its true definition. When people say they are applying for a mortgage, paying a mortgage, refinancing a mortgage, they really mean they are applying for, paying, or refinancing a home loan.

A home loan is a loan. It has its terms: principal, interest rate, number of months to pay, etc. etc. The home loan is evidenced by a Promissory Note. The Note is secured by the borrower’s home. The security document that pledges the home in exchange for the loan is called the mortgage in some states.

The mortgage is given by the borrower to the lender. The borrower doesn’t have a mortgage. The lender has it. The party giving the mortgage, the borrower, is called the mortgagor. The party receiving the mortgage, the lender, is called the mortgagee. The mortgagee (lender) has the mortgage from the mortgagor (borrower). If the borrower defaults on the loan, the mortgagee goes to a court and asks a judge to foreclose the borrower’s home. This is called a judicial foreclosure.

That’s how it works in some states. In other states, the borrower does not give a mortgage to the lender. The borrower signs a Deed of Trust. That makes the borrower the grantor of the trust, and the lender the beneficiary of the trust. There’s a 3rd party trustee for the Deed of Trust. The trustee listens to whoever ends up owning the Note. If the loan servicer tells the trustee to sell the home, the trustee will sell the home. With a Deed of Trust, the trustee doesn’t even have to go to a court to get a judge to approve the foreclosure. They do it by themselves. It’s called a non-judicial foreclosure.

My state uses a Deed of Trust. I’m the grantor. MERS is the beneficiary. Some articles on the web say 34 states in the U.S. use a Deed of Trust either exclusively or primarily, although I count only 21 states in this Mortgage and Deed of Trust State Matrix published by a loan document production company Document Systems, Inc.

---
Software picked, likely related articles at The Finance Buff:

• What Did the Appraisers Do Wrong?
• Refinanced to Foreclosure
• Signed Mortgage Refinance Documents

Before I make the first payment on my new loan, my new lender already sold the loan to another bank. Actually their paired me with that other bank at the time I locked my rate. I expect a letter from this new bank with a new loan number. The whole refinancing process took 40 days from the day I submitted the loan application to the day my old loan was paid off. I’m glad it’s finally done and over with.

In retrospect, I think I entered the value of my home too high on the mortgage application for the automated underwriting system. That triggered the requirement for a full appraisal. Had I given the lowest value necessary for my refi, I might have been able to get my application approved without requiring an appraisal or with only a drive-by appraisal.

A big chunk of time spent in my refinancing process was waiting for the appraisal report. I had wanted to close the refi before I went on vacation. I wasted two weeks and much anxiety on waiting for the appraisal. I may also have been able to save myself a few hundred dollars if I didn’t need an appraisal.

It may be counter-intuitive, but when you do a mortgage application, put down the value of your home as low as necessary. If you only need 80% loan-to-value (LTV) ratio, giving a high value for your home and making your LTV lower than necessary does not help you and it may cost you both time and money. The automated underwriting system does not believe the high value you give it anyway.

If I could do it again, I would also use my own local settlement agent as opposed to the settlement agent selected by the lender. At the time of signing, the lender’s settlement agent sent over a notary to my office. That was convenient, but the notary does not work for the settlement agent. She’s just an outsourced contractor for gathering signatures. As such, she couldn’t answer any question about the settlement process: Will the payoff be by wire or by check? Will it be done on the same day as the funding or on the next day? Nor could she explain the loan documents. She only got the loan documents that same morning.

After she collected the signatures and signed where a notary was required to sign, she sent the whole package off by FedEx to the settlement agent a thousand miles away. If there were any problems or somebody missed a signature somewhere, it would be hard to correct them. In the past, I went to a local office. The person at the signing table was the settlement agent. They were able to answer all the questions and explain the documents. After everything was done, they sent me a CD with all the documents I signed. That made filing so much easier. Now I have a big stack of documents, most of which I have to shred.

Let’s not forget using the lender-picked settlement agent a thousand miles away also caused me the last-minute scramble for the required certified check. I will manage the process better next time.

On the bright side, I caught a dip in mortgage rates. The lender delivered what they promised. The rates are about 0.5% higher now. With no out of pocket cost and no increase in principal balance, only the investment of my time in filling out forms, sending faxes, writing e-mails and making phone calls, I was able to lower my mortgage rate and save about $1,000 a year for many years to come. A 4.5% mortgage is worth the investment of my time and energy. I will be watching for more dips in the future.

---
Software picked, likely related articles at The Finance Buff:

• Last Train for Mortgage Refinance
• Mortgage Rates Back to April Lows
• I’m Refinancing My Mortgage

Week 1. Found a good rate. Filled out application.

Week 2. Locked rate. Signed disclosure documents. Faxed supporting documents.

Week 3. Home appraisal. Decided against waiving escrow for a fee.

Week 4. Nothing happened. Appraiser could not produce the appraisal report. Lender agreed to extend rate lock at no charge.

Week 5. Appraisal report finally came. The appraised value was about 20% less than what Zillow shows but it would not affect my ability to refinance. Underwriter approved the loan.

Week 6. Scheduled document signing. The lender’s contracted settlement agent sent over a notary to my office. I signed the documents in front of her. She would then forward the whole thing to the settlement agent by FedEx.

My overall experience with the lender National Mortgage Alliance is positive. The final closing statement matched the rate quote I received initially. There is no bait and switch. The loan advisor is accessible and responsive. My e-mails were replied within hours. When I called, I often got to speak to her, which I couldn’t when I worked with the mortgage broker I used (90% of my calls went to voicemail). I also learned through this mortgage refinance process about the business model of a direct lender. I will write about it in another post in the future.

P.S. It looks like I just dodged a mortgage rate tsunami. The mortgage rate jumped as much as 0.75% in a single day yesterday. From Mr. Mortgage Blog: 5-28 – Potential Consequences of 5.5% Mortgage Rates (via Mish). I’m keeping my fingers crossed that the loan will fund.

---
Software picked, likely related articles at The Finance Buff:

• Credit Card Cash Advance Saved the Day
• Mortgage Refinance Documents: OMG What Did I Sign?
• Mortgage Refinance Completed

Week 1. Found a good rate. Filled out application.

Week 2. Locked rate. Signed disclosure documents. Faxed supporting documents.

Monday May 4, 2009. An appraiser came and did an appraisal. I didn’t have to do a full appraisal in my last several refinances. Last time the broker paid $100 appraisal waiver fee (cheaper than a real appraisal). Before that, they did a "drive-by appraisal," just verifying the house was standing. This time the lender insisted on a full appraisal. Either the lenders are more cautious than before or it’s a mandate from Fannie Mae. No biggie. It just adds an extra step to the process.

I also had to decide last week whether I want to do the impound aka escrow account for my property tax and homeowner’s insurance. The alternative is to pay an extra fee and have them waive that requirement. Lenders prefer that the borrower pays property tax and homeowner’s insurance into an impound or escrow account. That way they will make sure the tax and insurance bills are paid. It protects their interest. They also earn some float from the money. My loan advisor told me Fannie Mae charges them a fee if the loan does not have an escrow. They are passing that fee down to me.

Most people if given a choice probably will not use impound or escrow account because it unnecessarily complicates paying the tax and insurance bills. But if you have to pay a fee to get rid of annoyance, you have to decide if the fee is worth it. You can try to negotiate away the escrow waiver fee. At the same time, if you are also able to negotiate an additional credit in lieu of the escrow waiver, you are still effectively paying the fee because you give up the additional credit.

From a lost interest point of view, paying a fee to waive the escrow is not a good deal right now. The interest rate is very low. In some states you actually earn a little bit of interest in the escrow account, which to some degree offsets the lost interest. I made this break-even calculator

Impound / Escrow Waiver Fee Break-Even

It shows it will take several years to earn back the fee from the lost interest.

I also learned I will have a good chance to get the escrow waived after the loan is sold. It depends on who ends up servicing the loan. Some servicers will close the escrow account upon request if the loan-to-value ratio is sufficiently low. I decided to take my chance after the loan is sold. I will do the escrow and pocket the escrow waiver fee.

The loan advisor warned me that the money I must bring to the table at closing will be higher if I don’t waive escrow, because they have to collect a few months of tax and insurance as cushion for the escrow account. I’m OK with that because that amount is a cash outflow, not a cost.

---
Software picked, likely related articles at The Finance Buff:

• Does a Mortgage Escrow Account Pay Interest?
• Mortgage Refi Journey Started
• Signed Mortgage Refinance Documents

Week 1. Found a good rate at National Mortgage Alliance (NMA). Received quote on GFE. Filled out application online.

Monday 4/27/2009. Rate lock confirmed. 4.5% for 15-year fixed. Lender credit covers all closing cost. Escrow waiver is optional for a fee.

Tuesday 4/28/2009. Received the disclosure document package through a secure link online. Signed all the disclosures. Faxed back total 45 pages including these supporting documents:

• copy of driver’s license
• last year’s W-2
• 2 most recent pay stubs
• bank statement
• poof of homeowner’s insurance

Friday 5/1/2009. Loan advisor confirmed all the disclosure documents were properly executed.

My previous refinances were done through a mortgage broker. This time I’m doing it through a division of a bank. That makes it a mortgage lender, not a mortgage broker. What’s the difference between working with a mortgage broker versus working with a mortgage lender? None I can tell so far.

A mortgage broker arranges loans from other banks. They do not set lending standards or fund the loans. They are just a middleman introducing the borrower to a lender. A mortgage broker gets paid from making that introduction. I dug up the paperwork from my last no cost refi in 2008. Here’s how much the broker got paid:

The broker earned $3,371 from doing my refinance. That’s pretty good for taking some phone calls and forwarding some paperwork, isn’t it?

Was I duped? Could I have gone to the bank directly and saved $3,371? Unfortunately, no. A mortgage broker sells loans like Amazon sells iPods. Apple, which makes iPods, also sells iPods directly to consumers in its own online store and retail stores. But the price from Apple’s online and retail stores is not any lower than the price at Amazon. Amazon’s price is actually a little less. Amazon buys at wholesale price from Apple and then sells at retail price to consumers. Apple’s own online store and retail stores also sells at retail price. Going through a mortgage broker in itself does NOT necessarily mean the rate and fees will be higher than what one gets from going to a bank directly. For the bank, mortgage brokers are just a sales channel. The bank’s own web site and retail branches are also sales channels.

Of course not all brokers are created equal. There could be a broker who is satisfied with only $1,500 revenue and is willing to pass on to me more of the money he or she gets from the lender. There could be another broker who wants to keep the entire $5,434 to him- or herself. Therefore you still have to know what the prevailing retail rate and fees are whether you shop for a mortgage. Whoever delivers the lowest rate and fees wins, regardless whether they are a mortgage broker or a mortgage lender. By shopping for a no cost refi, I eliminate one variable. I only look at the rate. As long as the rate is the best I can get elsewhere, I don’t mind letting the broker earn their fee. The broker lost out this time because he couldn’t match NMA’s rate.

---
Software picked, likely related articles at The Finance Buff:

• Mortgage Ecosystem: Direct Lender
• Signed Mortgage Refinance Documents
• Mortgage and Home Loan

I called the mortgage broker he referred to me but the broker is not licensed in my state. I also remember that Raghu wrote about his refinance experience last December. I actually commented on a few of his posts back then because he had listed my blog as one of his favorites.

Raghu mentioned in his posts last year that he went with National Mortgage Alliance (NMA), which is an Upfront Mortgage Lender certified by the Mortgage Professor. NMA lends in all 50 states and Washington DC. When I checked NMA’s no-cost refi rates, I was offered 30-year fixed at 4.875% and 15-year fixed at 4.5%, both with a one-time 0.125% escrow waiver fee and $120 in document preparation and government recording fees.

If I agree to use escrow, then I just pay $120, which is not strictly no cost, but close enough. Other places I checked all want at least $2,000 in closing cost for the same rate. Score! Thank you Raghu!

Doing a mortgage refi with a company I never dealt with before makes me uneasy, especially when its rate and fees are so much lower than others. If I do a loan application, I have to give out my Social Security number and a lot of personal information. What if an ID thief sets up a web site to collect mortgage applications? What if it’s a bait-and-switch? But because NMA is certified by the Mortgage Professor and because Raghu said his closing went smoothly, I think NMA is legit.

I’m going to document this refinance journey and let you see how things pan out. If you haven’t refinanced lately, perhaps it’s time to consider doing it.

Wednesday 4/22/2009. Looked up loan rate and fees from NMA. Requested that a loan advisor contact me. Received an e-mail and a phone call within a few hours but I was too busy with work to reply.

Thursday 4/23/2009. Spoke to the loan advisor. Received a Good Faith Estimate (GFE) by e-mail showing the closing cost will be credited except a 0.125% escrow waiver fee and $120 in doc prep and government recording fees. Same as what I got online, good. Asked a few questions:

• Can appraisal be waived? – Fill out an application first. Then wait for a preapproval from the automated system.
• Is there a prepayment penalty? – No.
• Are there any non-refundable fees upfront? – A $300 deposit is required to lock the rate. It will be credited at closing. If you don’t close, the deposit becomes non-refundable if an appraisal is performed. Fair enough. Appraisal costs money.

I called the mortgage broker I used many times in the past. He couldn’t beat the deal. Filled out application online with NMA in the evening. Gave a credit card number for the $300 deposit for locking the rate.

Friday 4/24/2009. Got an e-mail from the NMA loan advisor saying their automated system says an appraisal is needed. Stupid computer! But the loan advisor offered some additional credit toward closing. OK, that’s good. Got a few more e-mails for this and that. All taken care of. The loan advisor replied all my e-mails promptly. When I called her, she always answered. My calls never got to voicemail. So far so good.

The journey continues. I will probably do weekly recaps on Mondays. More frequent updates will be posted to Twitter.

---
Software picked, likely related articles at The Finance Buff:

• Waiting For a No Cost Mortgage Refinance
• "No Cost" Mortgage Refinance: Stepping Down the Ladder
• Signed Mortgage Refinance Documents

I kept asking my trusted mortgage broker about refinancing but he kept telling me “rates are not yet lower than what you have now.” In case he’s no longer able to get competitive rates because the banks are cutting off mortgage brokers, I also tried getting rate quotes myself directly from the banks.

Pentagon Federal Credit Union (PenFed) used to have good rates and no lender closing cost. Now they added a 1% origination fee on all their fixed rate mortgages. That totally killed the deal. Right now I can see 4.5% rate from a few places but they all require about $3,000 in a combination of points, fees, and closing cost.

When you evaluate whether paying the closing cost on a mortgage refinance is worth it, you shouldn’t just compare your current loan with the refinanced loan. You should use a no cost refi as the baseline because you are able to get it anyway.

For example, suppose you have a loan at 7% and the current rate is 5% with a $3,000 closing cost. If you run the numbers through the mortgage calculator, you see you are able to save money over the expected life of your loan, and therefore you conclude that paying the $3,000 makes sense. But wait, if you are able to refi to 5.25% with no cost, you should really compare the 5.25% no cost refi with the 5% plus $3,000 closing cost and see which is better.

I locked in the rate for my last refi in January 2008 at 4.875% for a 15-year fixed rate mortgage. That was two months before Bear Sterns collapsed. Way before Lehman went bust. S&P 500 was 1,300 back then (now 870, lowest 666 in March 2009). 10-year Treasury yield was 3.4% (now 2.9%, lowest 2.2% in January 2009).

You would think with the stock market down, bond market up, the mortgage rates would be down significantly. Yet the mortgage rate never came down low enough for me to refinance. I ran the numbers with the Mortgage Professor’s refinance calculator. I see I’m able to save a whopping $85 over 10 years if I pay $3,000 in closing cost and refi to 4.5%. It’s just not worth it.

So I’m still waiting. If I’m able to get 4.5% with no closing cost, I’ll do it. I still want to do a no cost refi because for my circumstance, the bottom line cost between a no cost loan at a higher rate and a with-cost loan at the lower rate is negligible ($85 over 10 years).

Why are rates not down? I think the banks want higher margins now than they did before. The rate at which they can sell the mortgages to Fannie Mae is down, but the rates to borrowers are not down nearly as much.

[Updated on April 27, 2009: Found a place offering the rate I wanted. Refi journey started.]

---
Software picked, likely related articles at The Finance Buff:

• Mortgage Rates Back to April Lows
• "No Cost" Mortgage Refinance: Stepping Down the Ladder
• Last Train for Mortgage Refinance