| In the first part of this two part series, we | | | | closing costs. |
| covered the different types of home loans and | | | | The next logical question is, "why would I want to |
| the role of a mortgage broker in the "no cost | | | | have a higher rate just to avoid closing cost?" |
| refinance." Now let's look at what information we | | | | This is an excellent question and the answer |
| need in order to maximize our savings. As | | | | depends on your time horizon. It's a bit different |
| previously discussed, the no cost refinance uses a | | | | for every loan, but typically if you plan on selling |
| lender credit to cover the cost to close a | | | | your house or refinancing your loan within the |
| refinanced home loan. The lender credit is | | | | next four to fives years, it would behoove you to |
| generated when the mortgage broker sells you a | | | | take on a higher rate and avoid closing costs. |
| loan at a rate that is higher than the current | | | | After four or five years, the savings from the |
| market rate. This is known as the yield spread | | | | lower rate covers the closing costs you shelled |
| premium (YSP). The key to having the YSP work | | | | out, so if you are ready to lock in a loan for the |
| in your favor (cover closing costs) as apposed to | | | | long haul, it may be a better idea to get the |
| lining your mortgage broker's pocket is being well | | | | lowest rate possible and pay closing costs out of |
| informed on the market wholesale rate and the | | | | pocket. Without accounting for the time value of |
| YSP compensation. | | | | money, the basic formula to calculate this tipping |
| Unfortunately, there is no clean cut way to | | | | point in years would be: |
| decipher these two pieces of information, but | | | | Closing Cost / [(Monthly payment with higher rate |
| there is a way to get a ballpark figure. The best | | | | - Monthly payment with lower rate) * 12] |
| proxy for the wholesale rate is the Fannie Mae | | | | After you crunch the numbers, if you decide that |
| Weekly Yield. This rate is published every Monday | | | | the no cost refinance might be the way to go, |
| and corresponds to the yield (return) being | | | | the next step is to figure out your total closing |
| offered on their current mortgage backed | | | | costs. Closing costs can be broken down into |
| securities. Since Fannie Mae is huge agency | | | | three basic categories -- lender fees, third party |
| backed by the "full faith and credit" of the US | | | | fees, and prepaid expenses. The first set, lender |
| government, their rates are typically the lowest in | | | | fees, are determined by the mortgage broker |
| the market, so this rate might be slightly lower | | | | and should be disclosed up front. The second |
| than what banks are offering your mortgage | | | | group of fees are charged by all the other "hands |
| broker. Once you have a proxy for the wholesale | | | | in the cookie jar." These fees can vary from |
| rate, you can determine the yield spread on your | | | | state to state, but most mortgage brokers should |
| loan by taking the rate offered to you and | | | | be able to estimate a reasonable figure. The last |
| subtracting out the wholesale rate. As an | | | | set of expenses includes the ongoing costs of |
| example, let's say the wholesale rate is 4.5% my | | | | owning a home -- insurance and taxes. Since the |
| quote comes in at 5.0%, then my broker is | | | | last group is made up of expenses that a |
| collecting a spread of 0.5%. | | | | homeowner is already paying and will continue to |
| The compensation for this spread is also hard to | | | | pay whether they refinance or not, I typically do |
| determine as it tends to fluctuate as market | | | | not roll these into the lender credit. Remember, |
| conditions change, but a good rule of thumb is | | | | the more fees you roll into the lender credit, the |
| around 1% of the loan value for every 0.25% | | | | higher the rate will be to get enough "juice" (or |
| above the market rate. Continuing on with our | | | | yield spread premium) out of the loan. |
| example, let's say I was getting a loan for | | | | Once you determine the dollar amount you need |
| $250,000. That would mean the bank issuing the | | | | to close (with or without prepaids), you can ask |
| loan would be paying my broker an additional | | | | that your mortgage broker quote you a rate with |
| $5,000 (2% of the loan value since my rate was | | | | $X of lender credit. Then take your quote and |
| 0.50% above market) for bringing in a loan that | | | | the rule of thumb calculations discussed earlier to |
| was priced better than the market rate. It is this | | | | see if your broker is getting you a good deal or |
| additional compensation that we want to use for | | | | pulling his best snow job. |