How no-cost mortgages save buyers money when rates come down

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com

Article originally posted in Orange County Register on February 22, 2024.

Rumor is that the Fed might drop short-term rates three times in 2024.

That’s good news for homebuyers as fixed-rate mortgages tend to follow the Fed’s lead.

Today, a well-qualified buyer can get a conventional 30-year, fixed rate of 6.5% with a 1-point cost. Each point represents 1% of the loan amount.

Points represent interest paid in advance. Points also are tax-deductible and are paid in exchange for a lower interest rate.

Points also work in reverse. The lender can push rebate points back to the borrower in exchange for accepting a higher mortgage rate.

If fixed mortgage rates come down later this year, then what?

Did you just throw good money after bad?

On a $600,000 loan at 6.5%, the principal and interest payments equal $3,792. Let’s assume closing costs are $6,000 (in addition to the $6,000 point cost).

Side-by-side, let’s assume you can get a 7.375% rate without points or any settlement costs, a so-called “no-cost” loan. That payment is $4,144, or $352 higher than the 6.5% rate.

I acknowledge payment affordability and qualifying may critically matter now. If that’s the case, then there’s no point in this exercise.

But, if the buyer has decided to buy now regardless of payment affordability, taking advantage of less buyer competition and has his or her eyes on a future refinance (assuming rates come down), then this strategy is worthy of consideration.

If rates don’t drop, then obviously 6.5% was the better deal over time. The math says it would take just over 34 months to break even ($12,000 divided by $352 payment savings).

It’s a big bet, but what if fixed-rate mortgages do drop? And, you can get a 6% rate without costs? The payment is $3,597. That’s $195 less than the 6.5% over the remainder life of the loan. Over 39 years, for example, it’s a $67,860 savings should the owner keep the mortgage. Plus, the $12,000 in closing costs were saved.

There is one other option to consider if a buyer wants some middle ground and is not certain about mortgage rates tumbling.

That would be 6.99% without points (but including the closing costs of $6,000) compared with the original 6.5% and 1 point or the 7.375% no-cost loan. That payment is $3,988. It’s $196 more per month than the 6.5% rate. And it saves you the 1% loan origination fee.

There has been a plethora of consumers over the years who were serial no-cost refinancers. This practice started in the middle 1990’s, with the advent of rebate pricing (In this case, the buyer accepts a higher than market rate in exchange for a rebate credit to cover costs.) Each time they could knock say $100 to $200 off their monthly payment without cost.

There’s always a chance we’ll see a mini-refi wave toward the end of this year.

Freddie Mac rate news: The 30-year fixed rate rose to 6.9%, 13 basis points higher than last week. The 15-year fixed rate averaged 6.29%, 17 basis points higher than last week.

The Mortgage Bankers Association reported a 10.6% mortgage application decrease compared with one week ago.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.875%, a 15-year conventional at 6%, a 30-year conventional at 6.5%, a 15-year conventional high balance at 6.25% ($766,551 to $1,149,825 in LA and OC and $766,551 to $1,006,250 in San Diego), a 30-year high balance conventional at 6.875% and a jumbo 30-year fixed at 6.75%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $766,550 in LA, San Diego, and Orange counties.

Eye-catcher loan program of the week: A 30-year jumbo fixed rate at 6.375 at 2 points cost.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com. 

If you enjoyed this article and want to receive weekly mortgage news for FREE, sign up for the newsletter HERE.

* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.