No-Cost Home Refinance: Is It Worth It?

By DARYL STRICKLAND

Nov. 1, 1998 12 AM PT

TIMES STAFF WRITER

Daniel Mayeda is at it again. For the second time this year, the Culver City homeowner is poised to refinance his house to take advantage of lower interest rates.

“It makes sense for me every time I do it because I save more than 100 bucks a month on my house payment,” said the 40-year-old entertainment lawyer, who has refinanced his home three times in the last two years.

Like consumers who trade one credit card for another to gain cheaper interest rates, Mayeda and a growing number of homeowners are pursuing new mortgages to lower their monthly payments and free up money for other uses.

Spurred by the lowest interest rates in decades, steadily rising home prices and the lending industry’s smoother application process, more homeowners than ever are refinancing.

Nationwide, the value of refinanced mortgages is projected to top $720 billion this year, which would exceed the record set in 1993 by nearly one-third, according to the Mortgage Bankers Assn. of America, a Washington-based trade group.

The group estimated that since 1991, U.S. homeowners have saved $50 billion by refinancing, and one out of three homeowners is expected to refinance during the current boom.

Increasingly, homeowners are turning to “no-cost” mortgages, which were created about five years ago and now account for an estimated 40% of the refinance market.

A no-cost loan isn’t exactly what its name implies. Borrowers like Mayeda pay higher interest rates, often half a percentage point above market, in exchange for initially saving thousands in out-of-pocket fees that a traditional refinance loan requires.

No-cost loans have helped convince millions of homeowners to eschew conventional wisdom that says mortgage rates must decline 2 percentage points before refinancing makes economic sense.

In an era of low interest rates, the trend has been a boon to the Southland’s home-lending industry.

The Benefits and Risks

Loan experts say borrowers should consider the benefits and risks before refinancing. Here’s how a no-cost refinance loan on a $200,000, 30-year loan at 7.75% interest compares with a traditional one.

In a traditional refinance, a borrower pays “points”--typically 0.5% to 2% of the loan--to obtain a competitive rate. In today’s market, 1 point, or $2,000 on our hypothetical loan, would buy a 30-year fixed rate of 6.625%. That would reduce the borrower’s monthly payment to $1,280.62 from $1,432.82, a savings of $152.20 a month, or $1,826.40 a year.

The borrower also pays a variety of fees for things such as title insurance, escrow processing and an appraisal report. Combined with the points, the costs of a traditional refinance run about $4,500 on a $200,000 loan. (The borrower also must come up with as much as one month’s prepaid interest on the old loan, which would amount to $1,290 in this example.)

The costs of this refinance would be recouped in 2 1/2 years.

If the borrower owned the house for the entire 30 years, he or she would pay $54,792 less over the life of the loan.

Under a no-cost refinancing, the upfront costs are built into the loan in the form of a higher interest rate, in this case, 7.125%.

Monthly payments would drop by $85.38 per month, or $1,024.56 per year from the consumer’s first mortgage. Over the 30-year life of the loan, that’s $30,736.80 less when compared with the original loan.

For borrowers like Mayeda, the big motivating factor is no out-of-pocket expenses, except for the $1,290 in interest prepaid on the old loan.

In three refinancings over the last two years, Mayeda has shrunk the rate on his loan to 7.625% from 9%, and his monthly payment to about $2,900 from $3,400.

“Each time I do this, I say: ‘This is it. Rates will never get any lower than this.’ But then rates will fluctuate and I find I can refinance again,” Mayeda said. “It doesn’t cost me anything out of pocket, only a little time filling out forms. But it’s worth it for the money I’m saving.”

The appeal of a no-cost loan is that it allows homeowners to shrink their interest rates, lower their monthly payments and pocket the savings without spending a dime.

“If somebody puts $85 on your front doorstep every month, and all you had to do was fill out the paperwork to ensure you’ll get the money, wouldn’t you do it?” asked John Greer, branch manager of Western Capital Mortgage in Irvine, who’s a big advocate of the no-cost loan.

Because there are no upfront fees, consumers can refinance whenever interest rates drop, fattening their reserves. “It’s a phenomenon that we see when we’re in these kinds of market conditions,” Greer said. “Literally, people are refinancing three and four times a year.”

Be Sure to Crunch the Numbers

Although swapping mortgages for only incremental rate cuts can mean saving thousands of dollars, lenders stress that homeowners do the math and calculate whether the sum is significant enough to warrant the refinance.

Here’s one method to determine whether a no-cost refinance works in a homeowner’s favor.

First, add up the number of remaining monthly payments on the current mortgage. Separately, multiply the monthly payment for the no-cost loan by 360 (30 years).

If the total of the remaining payments is less than the total of the no-cost loan payments, then stand pat. Otherwise, a no-cost loan could be the better option.

“It’s never a precise science, but we strictly advise that before refinancing, run the numbers and know at what interest rate levels does it make sense to refinance,” said Keith Gumbinger, vice president of HSH Associates, a New Jersey-based mortgage publisher. “Do the research, call the lenders, track down a dozen quotes, and once you find your price, lock in.”

One drawback to refinanced mortgages is that they can increase the cost of borrowing in the long term.

In the example above, if the borrower has made five years of payments on the original mortgage and then decides to refinance over 30 years, he could wind up shelling out $485,000. Had he kept the original mortgage, his total payments would have come to $430,000.

Some industry executives question whether refinancing is worthwhile if there isn’t at least a 1-percentage-point spread between the new and old mortgages.

“If it’s anything less than that, I’m not sure you’re saving many dollars,” said Dan Hanson, senior vice president of Norwest Mortgage Inc., one of the nation’s largest mortgage originators. He believes that with closing costs spread over so many years, homeowners could pay those fees back several times over.

Indeed, in the example above, if the borrower paid on the no-cost mortgage for the entire 30 years, he would wind up paying $19,479.20 more than if he had taken the traditional refinance route.

That doesn’t mean no-cost refinancing isn’t a good idea.

The majority of homeowners live in their homes for less than the length of their mortgage. And the savings can be plowed into other investments that have the potential to generate greater returns.

A variety of economic factors are contributing to the current refinancing boom.

Despite recent market fluctuations, rates have remained low by historical standards and far below the double-digit levels of 1990. In fact, mortgage rates have varied this year by only six-tenths of 1%, from 6.6% to 7.2%, creating the steadiest rate environment in two decades, Gumbinger said.

At the same time, housing values have risen, improving the climate for exchanging mortgages. During the last year, prices across the Southland have jumped, prompting more consumers to refinance. Median prices have risen nearly 11% in Ventura County, 9.7% in Orange County and 5.2% in Los Angeles County, said Axciom/DataQuick Information Systems Inc., a La Jolla real estate research firm.

The same pattern has emerged statewide. California homes surpassed their pre-recession peak earlier this month as a strong economy and a home-buying boom have pushed up values.

Through the first nine months of the year, refinancing volume in Los Angeles and Orange counties hit $35.5 billion, nearly triple the year-earlier rate, according to Axciom/DataQuick.

Lending Process Gets Easier, Faster

While homeowners have flooded the market looking to refinance, they also find themselves bombarded by lenders soliciting their business.

Today, mortgage rates are advertised in newspapers, on television and radio, through conventional mail and e-mail, and displayed on electronic billboards along Southern California freeways.

Many lenders also have Internet sites, at which customers can plug their numbers into a calculator to see whether it makes sense to refinance and, if it does, apply for a loan online. Other sites will send an e-mail alert when rates have dropped to a desired level. Still others allow homeowners to browse rates from several brokers.

No longer are customers required to meet in person with a loan officer. Those without computers can call their broker, relay their information over the phone and learn within minutes whether their loan has been approved. Computers, generating forms that used to be typed out, now fax or mail the forms to individuals in an instant. Some lenders even send messengers to a person’s home or office, or waive appraisals for repeat customers, streamlining the process further.

Gary and Kathy Rigdon simply call Greer, their lender, who sends them an already-completed application, requiring little more than their signature. They have refinanced four times since 1995 and have another application pending on a 30-year loan that’s expected to close Monday, trimming their rate to 7.125% from 7.6%.

The Huntington Beach couple, who have five children, intend to consolidate their debts and make accelerated payments so their home loan can be repaid by the time Gary retires in 13 years at age 60.

“If it saves $50 a month, it’s worth refinancing,” Kathy said. “Instead of buying a new car, we apply that money to the mortgage and it pays off the principal faster, saving us interest.”

The refinancing boom has many mortgage lenders across the Southland--and other companies that feed on the real estate industry--expecting to report record results this year. During the last three months in particular, financial institutions said, they have been overwhelmed with customers.

Countrywide Home Loans Inc. of Calabasas, the nation’s largest independent home mortgage company, totaled $625 million in applications per day and a $15.9-billion backlog at the end of September, an all-time record. Tricor Mortgage Co. of Huntington Beach received 2,500 inquiries a day, more than double its normal volume, causing the company to cut back its advertising.

“It looks like our best year ever,” said John Gatzke, a senior vice president at Downey Savings & Loan in Costa Mesa. He expects the thrift to process $2.3 billion in refinanced mortgages this year, about 70% of its overall loan production. That compares with as much as 55% in previous years.

Refinancing Boom Expected to Continue

Title companies also have been absorbing their share of growth. First American Financial Corp. of Santa Ana, the nation’s largest title insurer, has reported five consecutive record-breaking quarters. Fidelity National Financial Inc. of Irvine also has announced record earnings and revenue for the quarter and nine-month periods ended Sept. 30.

Mortgage rates aren’t expected to rise dramatically in the coming months, leading analysts to believe the surge in refinancings will continue.

“As long as rates remain low, we’ll be in a refinancing boom,” said David Lereah, chief economist of Mortgage Bankers Assn. of America.

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Refi Madness

With mortgage rates on the decline, refinancing activity in Los Angeles and Orange counties hit $35.5 billion through September, nearly triple last year’s rate. Here’s a look at refinance volume in the two counties over the past eight years.

1998, September: $4.5 billion

Comparing Costs

In the example below, a no-cost refinance home loan would shave $85 a month and nearly $90,000 in interest over the life of a 30-year loan. Both amounts are less than a traditional refinance loan, but there are no out-of-pocket expenses. Here’s a comparison of the costs and savings on both types of loans for a home valued at $250,000 with 80% of the price being financed. The current monthly payment is based on a loan amount of $200,000 at 7.75% for 30 years.

*--*

Traditional No Cost Loan amount $200,000 $200,000 Interest rate 6.625% 7.125% Mo. payment $1,280.62 $1,347.44 Current payment $1,433.00 $1,433.00 Monthly savings $152 $85 Savings over life of loan $131,836 $87,413*

*--*

Cash Required to Close

*--*

Pre-paid interest $1,290 $1,290 Closing costs $4,576 $0 Break even on closing costs 30 months $0

*--*

Sources: Western Capital Mortgage, Axciom/Dataquick Information Services

Arithmetic of Refinancing

Would a refinance pay off for you? The only way to find out for sure is to figure out how much you’d pay in transaction fees and compare that with how much you’d save on you monthly mortgage payment. Here’s a work sheet to help determine the costs and potential savings.

The Costs:

Points

Application fee

Appraisal fee

Attorney fee

Credit report

Hazard insurance

Home inspection

Loan origination fee

Mortgage insurance

Recording fee

Survey fee

Title insurance

Underwriting fee

Other

Total cost

The Payback

1. Current monthly payment

2. New monthly payment

3. Monthly savings (Subtract Line 2 from Line 1)

4. Tax cost (Multiply Line 3 by your combined state and federal tax rate)

5. Net savings (Subtract Line 4 from Line 3

6. Break-even (divide total cost by Line 5 to determine how many months it will take to pay off the cost of refinancing)

7. Number of months you play to stay in the house

* Excerpted from “Kathy Kristof’s Complete Book of Dollars and Sense”

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On the Web

Here is a sample of Internet mortgage sites:

American Bankers Assn: htt://www.aba.com

Consumer World: htt://www.consumerworld.org

Federal Home Loan Mortgage Corp.: htt://www.freddiemac.com

Federal National Mortgage Assn.: htt://www.homepath.com

HSH Associates: htt://www.hsh.com

Mortgage Bankers Assn. of America: htt://www.mbaa.org/consumer-info

Mortgage Loan Page: htt://www.loanpage.com

National Foundation for Consumer Credit: htt://www.nfcc.org

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Point by Point

Here’s the avergae mortgage rate charges by Southland financial institutions on Friday based on the number of points--apercentage fee based on the size of the loan--a borrower pays to get a lower interest fee.

Points: 0

Combining loan (up to $227,150)

15-year: 6.48%

30-year: 6.83%

Points: 1

Combining loan (up to $227,150)

15-year: 6.23%

30-year: 6.58%

Points: 2

Combining loan (up to $227,150)

15-year: 5.98%

30-year: 6.33%