No-Cost Loans Make Sense For Those On Move

October 18, 1998

Stephen Marchel, a 36-year-old stockbroker, is a modern-day nomad. Over the past five years, he has bought and sold three homes. So when he went to buy a $560,000 house in New Jersey a year and a half ago, his mortgage broker introduced the idea of a no-cost mortgage.

Instead of Marchel's paying $10,000 in closing costs, his broker added about an eighth of a percentage point to his interest rate. "I didn't expect to be in this house long," Marchel says. "So it made sense to keep upfront costs as low as possible."

The no-cost mortgage is the latest financing and refinancing strategy to hit the U.S. housing market, which has been one of the hottest in recent memory.

With mortgage rates the lowest they've been since the 1960s and with personal incomes rising, houses are selling in record numbers. This has made the mortgage-lending business extremely brisk - and competitive

Enter the no-cost mortgage. The idea emerged in the early 1990s, when some lenders' 30-year fixed-mortgage rates fell as low as 6.8 percent. It came back. with a bang early this year, when rates started to slide again, most recently to 6.6 percent.

"No-cost mortgages have been around," says Keith Gumbinger, vice president at the mortgage research firm HSH Associates in Butler, N.J. "They've come out at times of particularly high refinance activity coupled with low interest rates."

Here's how the no-cost mortgage works: Borrowers pay no points, no closing costs and no fees for appraisals, credit checks or legal services.

Instead, they have two options: They can tack those fees onto the loan - that is, a $200,000 mortgage becomes $210,000, $10,000 being the closing costs.

Or they can increase the interest rate by three-eighths to five- eighths of a percentage point, depending on the size of the mortgage (the bigger the loan, the smaller the increase).

So instead of doling out $10,000 in closing costs and fees on a $200,000 mortgage with a 7 percent interest rate, you could pay no costs and fees and get a 7.5 percent rate.

That might not sound like a good deal, but remember: Interest costs are tax-deductible; closing costs are not.

"There's really no downside to a no-cost mortgage," says Richard Roll, president of the American Homeowners Association. "It minimizes the upfront cost, and all the interest is deductible."

On the other hand, a no-cost is more expensive through the life of the mortgage. Bumping the interest rate up from 7.08 percent, for example, to 7.58 percent on a $200,000 mortgage will add about $70 a month, or $25,000 over 30 years.

For whom does this make sense? For people like Marchel, who don't stay in their homes for very long. They won't have to pay all that extra interest.

When Doug Miller, who has been commuting between Denver and San Francisco since founding a computer-software company 21/2 years ago, decided to refinance his home, the no-cost option worked.

Instead of paying $2,000 in closing costs, he increased the interest rate by three-eighths of a point. The higher interest costs will be negligible, because he is selling his house so he can move to San Francisco permanently.

No-cost mortgages also make sense for people who would rather invest in stocks and bonds than in a down payment for a house or for people whose money is already in the market.

"If you have to cash stocks out to come up with $4,000 {in closing costs}, you'll have to pay capital gains and it's no longer going to be a performing asset," HSH's Gumbinger says. "That may not be the best allocation of your assets."

banks Who's offering no-cost mortgages? Mostly mortgage banks and brokerage houses, plus and savings and loans that have big mortgage-lending divisions.

But be careful: Some lenders claim to offer no-cost mortgages but actually provide a rebate - not a bad deal except that while the money is in the lender's hands it isn't working for you elsewhere.

Others charge an upfront 1 percent origination fee. Still other, less scrupulous brokers bump up their compensation by adding extra fees.

"Look at every line," advises Roll of the homeowners association. "But make sure the loan amount that's on the note is what you've agreed to."

Marchel, for one, is a fan of no-cost mortgages. He recently sold his house to move into a new, $605,000 home on the Jersey shore. He's using another no-cost mortgage this time around. "It's what made economic sense," he says.

Maybe for you too.

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