‘No-Fee’ Loans Too Good to Be True
Q: With interest rates dropping again and even more cuts expected this year, I wonder if it is the right time to consider refinancing the house I purchased last year when rates were higher. My mortgage broker has recommended that I do it and has suggested that I take a no-fee loan. She said there is no reason to pay the refinancing expenses out of my pocket or by increasing the amount of my loan balance. This sounds too good to be true since I firmly believe that there is no such thing as a free lunch. How should I evaluate this opportunity? --G.B.S.
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A: You are wise to be so realistic; if something seems to be too good to be true, it usually is.
First of all, you should know that there is no such thing as a “no-fee” loan. All loans--no matter what they are called--carry some form of loan-origination charge, usually called points, in addition to their annual percentage rate of interest. Usually, there is an inverse correlation between a loan’s interest rate and the number of points you pay to get it: The lower the points, the higher the rate and vice versa.
In practical terms, this means that unless you pay your fees with cash in hand when the loan is made, you will finance those charges over the life of the loan. There are two ways to do this: You can add them to your existing mortgage balance, thereby increasing the amount you owe. Or you can accept a so-called no-fee loan, which essentially is a loan with a slightly--or even considerably--higher rate of interest on the entire amount.
According to Helayne Levy, president of Affiliated Mortgage Capital, a Santa Monica mortgage brokerage, lenders currently are offering fixed-rate, 30-year conforming residential mortgages at 7% with 2 points. (A point is 1% of the loan amount.) However, the same loan with “no fees” carries an 8% interest rate, which you will be paying the whole time you have this mortgage.
For the sake of discussion, let’s assume the equity in your house is sufficient to allow you to refinance as well as to add on to your mortgage whatever loan fees you are charged. Now let’s look at the differences between adding on the fees and accepting a “no-fee” loan. (We’re not considering paying the fees out of pocket because many homeowners don’t have that kind of cash at their disposal. If you do, you can decide for yourself if you would rather invest it or spend it for the refinancing, a decision that depends primarily on the return the investment could generate.)
On a mortgage of $200,000, a homeowner electing the 7% loan with 2 points would likely have loan-origination fees of $5,000, bringing the mortgage total to $205,000, according to Earl Peattie, president of Mortgage News Co. in Santa Ana. At 7%, the monthly payment would be $1,363.88. If the homeowner had elected a “no-fee” 8% loan, the monthly payment would be more than $100 higher at $1,467.53.
After five years, the homeowner selecting the 7% loan would have paid $69,801.83 in interest charges on the loan, while the homeowner with the “no-fee” loan would have paid $78,191.45. Over the full 30-year life of the loans, the homeowner electing the 7% option would pay $285,984.54 in interest charges, while the 8% loan holder would pay $328,309.36.
You can probably decide for yourself whether what your mortgage broker told you is too good to be true.
Figure Social Security Contributions for ’96
Q: Now that we’re into a new year, the tax-deduction meter is reset. How much will I have to pay to Social Security this year? --F.U.
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A: For 1996, the 6.2% Social Security tax will be levied on the first $62,700 of your earnings, for a total of $3,887.40. The 1.45% Medicare assessment will be levied on your entire earnings for the year.
Resolve to File Honest, Accurate Tax Return
Q: I own a home with a relative and we have split the mortgage costs for the last four years. But he has always taken the mortgage interest deduction on his taxes. Now I would like to begin taking my share of the deduction. Will there be a problem? --N.D.
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A: Technically, you should have both taken the mortgage deduction since you have shared payment of the mortgage equally. And the fact that your relative has taken the entire deduction could pose problems for him if the IRS ever audited his filings.
That said, since you are both on the deed and are both paying the mortgage, you should not face any penalties for claiming your fair share of the deduction now.
Will your changing deduction practices mid-course tip off the IRS? An accountant we trust says you needn’t feel great fear given the relatively small amounts involved. To “get caught,” the IRS would have to compare deductions line by line on your filing for this year and last. You can’t rule out that possibility, but the experts say the odds are in your favor. Resolve for the new year to make accurate filings with the government.
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Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or send e-mail to carla. lazzareschi@latimes.com
