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You can adapt the old cultural cliché, “There’s no free lunch,” and apply it to the mortgage industry by changing it to “There’s no free debt.” An honest mortgage broker will tell you that what looks like a mortgage with reduced or no closing costs is really a loan with teasers that are paid for elsewhere. The auto industry has perhaps put a benchmark on this practice by establishing the concept of a “Manufacturer’s Suggested Retail Price” (MSRP) so hideously inflated that the auto dealer can offer you, the lucky customer, a price reduction of five or six thousand dollars!
Can’t afford to pass it up. While the mortgage business doesn’t engage in tactics quite as brazen, it’s fair to say that companies who are offering mortgages with no fees are virtually always folding some or all of those fees into the mortgage structure itself. You may be presented with the option of a mortgage with points and fees set at one interest rate, and the same loan without points or other fees at a higher interest rate. The higher interest rate option might make sense for someone who is planning to refinance the house in the not-too-distant future, or sell the home and move on. But it’s a fair guess that the higher interest mortgage, if allowed to run for thirty years, would cost substantially more than the fees and points charged up front in a more typical arrangement.
No-fee mortgages are, to a certain extent, the product of the refinancing frenzy that accompanied the jump in home values over the last four years. Combined with record low interest rates, refinancing became a reasonable financial decision for large numbers of homeowners. Refinance mortgage competition was such that mortgage companies were looking to offer deals “too good to pass up.” The people engaged in taking equity out of their homes at low rates were willing to overlook rates that were somewhat higher to offset fees, in part because they were focused on the pile of expendable cash that was about to come their way.
Some lenders are less than candid about exactly what fees are being eliminated. A careful study of the seemingly hundreds of documents you sign at a closing will reveal a substantial number of fees, taxes and charges that, because they lumped together, get little scrutiny. A lender may be waiving his origination fee but not the legal fees involved in the refinancing process – which may be the higher of the two costs. It is the responsibility of the borrower to push the mortgage agent on exactly what fees are being eliminated and what closing costs will remain.
Generally speaking, a no-fee loan is going to make sense if it’s going to be refinanced within five years or so. They were spawned by the refinancing boom and it is only in that environment that they make sense – at least in their current form(s). Lenders know and borrowers should recognize that every economic feature has its cycle. Interest rates and housing values are not excluded. So don’t assume, going into a refinance deal, that it will still be a good idea in five years. Hope for the best, and plan for a return to the norm.
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