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Too Good to be True?

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Posted On: 06/13/2012

ANSWER:

I did a “no-cost” refinance about a year ago. The deal worked like this: My lender offered to refinance my loan to a lower rate with no cash closing costs. By “no-cost,” the lender meant that it would pay all settlement expenses except escrow account deposits.

It may seem unlikely, but lenders can find it beneficial to offer this “no-cost” refinancing option for some specific borrowers, depending on the economic climate and the borrower’s financial standing.

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Since lenders – like everyone else – are in business to generate a profit, how could they possibly make money on a loan with a lower interest rate and no cost to the consumer at closing? Two ways.

First, the lender could charge a higher interest rate than you might get elsewhere. Even though the new rate may not be the absolute lowest rate available, if it means smaller monthly costs than what you’re paying today, it could be attractive to the borrower, especially if there really are no closing costs.

Second, the lender can sell the loan to mortgage investors and get cash from the transaction that way.

But why would the lender want to refinance an existing loan with a higher rate from a steady borrower?

Most probably, the lender no longer owns the loan. The mortgage has been sold and the lender now provides servicing such as collecting the monthly payments from the original borrower. The lender knows from credit records that the borrower is making payments and that the loan is likely to be refinanced because rates have fallen. Rather than lose a good borrower, the current lender steps in and offers a new loan, a better rate and lower costs. The sweetener is that the borrower pays nothing for closing costs.

If you’re considering a “no-cost” refinance, make sure the lender provides a good faith estimate of closing costs before you accept any offer. Check the sheet with care and shop around. Also, see if you need cash at closing for any items not covered by the lender’s offer.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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