How does a mortgage refinance work?

If you’ve decided that you want to refinance your mortgage, for whatever reason, some examples of reasons to refinance are annotated over at Boston mortgage refinance, but you can refinance with a no closing cost mortgage by taking a higher interest rate. Like I’ve mentioned in prior posts, if you don’t believe you will be in your house for longer than a few years, a no closing cost mortgage is the way to go so that your not sitting on large closing costs that you incurred by refinancing.

So how does a mortgage refinance work? I’ll try to explain it in a way that is easily understandable and you can use this information while you refinance your mortgage. Be mindful that different states and localities have different ways of doing business, so if you live in Philadelphia, you may want to check up on important Philadelphia refinance information.

In the beginning, you found a house you wanted to purchase and used a purchase mortgage to acquire said house. You went with a broker or lender and filled out the paperwork and everything worked out well and now you ‘own’ your house, or are making payments towards owning your house. Since you purchased your house the mortgage rate has gone down or because of reasons listed above, you have decided that you want to refinance your mortgage to a lower rate.

You should research different lenders and speak to a couple of mortgage brokers to get a handle on the fees they charge to give you a loan. When it comes to fees, there are lender fees, and then there are third party fees. Lender fees are the fees that the lender charges you to give you a loan. They do of course have employees that they have to pay and overhead that they have to pay for as well. The third party fees are the fees charged by people or companies to do work on your loan, for instance the appraiser or title company. Lender fees are controllable by the lender and you can work on those fees with the lender. Third party fees however are not controlled by the lender and they can’t do anything about those fees.

Once you have decided to apply for a mortgage, by law, you are supposed to receive a GFE, or good faith estimate, from the lender outlining all of the different costs or fees that they are guessing will be incurred to give you a loan. Now, I say three days and it is required by law, however, many brokers don’t usually take the time to give you a good faith estimate for whatever reason. This could also potentially be a reason of concern because in my opinion, it could be reflection of the quality of institution or person you are dealing with.

Once you receive that GFE, or get off the phone with the broker and or lender, they will request some documentation from you. The usual documentation requested is your paystubs for the last two months, your W-2 from the last year to see if you earned what you said you earned the year prior, and IRS form which allows the IRS to share your tax information with the lender, and a couple other forms for you to fill out. They may also want all or a few of your checking and or savings account statements to see if you have any money in the bank. They also will need to know who your current mortgage lender is so that they can request a loan payoff and ensure that the amount you are asking for is in line with what you owe unless you are wanting cash out of your house. Now this is not an all encompassing list of the documents they may request, but these forms are normal and you shouldn’t get worried about sharing this information with the lender.

While you are gathering your information, the bank will order an appraisal to find out how much your house is worth so that they are not giving you more money than what the house is worth. The appraiser may want to see the inside of the house, or they may just drive by the house, possibly take some pictures of the outside, and come up with a value for your house. If they want to see the inside of your house, they will make an appointment with you so that they can get into your house and see what it looks like. Coming up with a value for the house is not just what this person may or may not think it’s worth, but they use information from houses around you as far as how much have they sold for, then they make adjustments to come up with a value for your house. The easiest way to come up with a round about figure is find out how much the houses around you sold for on a per square foot basis. Then, average all those figures out, and then multiply it by how many square feet your house is and you have a figure to see about how much your house is worth.

If you have a HEL or a HELOC, the new lender will ask the old lender for what is called a subordination. What happens when your first mortgage gets paid off is then the second mortgage will jump into the first position. Well, if your new lender is supposed to be in first position, then they will ask the lender of the HEL/HELOC to subordinate, or jump back into second position once the original first mortgage is paid off. Lately however, individuals are having a hard time getting the second mortgage to subordinate. You may have to call and hassle them a little to get them moving and this could potentially hold off your closing until it is accomplished. Some HEL/HELOC lenders also may charge a fee to subordinate. Again, this will also have to paid for.

Once they receive this information, you loan documentation with the application will go to what is called an underwriter. What this person does is review all the documentation and ensure it meets all of the lenders loan requirements. If they don’t like something or feel that something is missing, you may get a request for more information or additional forms. Again, this is normal and nothing to be concerned with. Once this is all completed, the lender will order what is called title insurance. This protects the bank so that if anything comes up like there is a title problem, the property because unmarketable, the lender is protected, the lender is protected.

Once title is completed, then a closing is scheduled so that you can go and sign a bunch of mortgage documents and close on your house. Once that is completed, the forms are sent to the bank and you are almost finished. There is a federal law that protects the borrow from having buyers remorse called the three day right of rescission. Because a mortgage is such a large transaction and most likely the largest most of us will make, they allow you three days to write the lender back and say, never mind, I don’t want this loan anymore. Once those three days are over though, your new lender will send the money to your old lender who will then consider your loan paid off. Something to consider however, is because technically you have money from two banks, you will be paying interest on that money for three days on two different mortgages. That interest expense begins when you sign the paperwork, including weekends. SO, don’t sign your paperwork at the end of the week because you will be paying interest for two extra days while you wait for the weekend to finish. If you sign your closing paperwork on Monday, you pay double interest until Wednesday or three days. If you close on your mortgage on Friday however, your paying interest for five days. The other thing is also to close your mortgage as close to the end of the month as possible to limit how much prepaid interest you have to pay before the end of the month.

For instance, if you close on your mortgage on the fifth of the month, you will pay interest at the closing table from the fifth until the end of the month. If however, you close on your refinance on the 25th, you are only prepaying interest for five to six days only. If your paying your own closing costs, this could be a way to lower your closing costs.

Once this is completed, then the old lender will refund to you any escrow amounts that they may have been holding and make sure you get any money back that you were due because of overpayment or bad calculations. Most people should receive a refund on money although some may not receive any.

This is a shortened description of how a mortgage refinance works. If you are however going to be getting a no closing cost mortgage however, everything will be the same except for the closing costs portion because technically, you are not paying for any of that. The only thing that would apply in a no closing cost mortgage is your closing date. Again, try to get the date to occur early in the week so that you are not paying costs for two mortgages for longer than the prescribe three days.

I am currently still in the middle of my no closing cost refinance with Wells Fargo and will update once I’m finished. Everything however is still the same as I mentioned above and everything has been pretty painless.

VA No Closing Cost Mortgages are a bad deal!

Veteran's Administration, or VA loans for military personnel and individuals who have been honorably discharged from the military allow those individuals to purchase a house with no money out of their pocket, effectively making the mortgage loan a no closing cost mortgage. The cost is there and I'll hopefully show you why VA mortgages are not the best way to go.

When you get a conventional mortgage, most lenders will charge you a 1% origination fee on top of normal fees that are charged for a mortgage. That 1% is an additional charge on top of other customary closing costs like appraisal fee, credit report fee, processing fee, title insurance, etc, so that brokers can be paid and people can earn a living. While that in of itself is not bad, competition allows other lenders to not charge that fee. Ultimately however, you need to look at the total cost for acquiring a mortgage to ensure that you get a good deal. This is all not applicable of course if you are NOT getting a no closing cost mortgage.

When you take out a VA mortgage, you also pay an origination fee like I mentioned above. With VA loans though, instead of paying PMI, or Private Mortgage Insurance, you pay a fee to the VA so that they can guarantee your mortgage. BUT, if you have equity in the house or as a down payment, AND you have good credit, save your money because the VA charges the following fees to guarantee your mortgage.

Type of Veteran	Down Payment Amount	First Time Use	Subsequent Use for Loan until 09/30/11
Active Duty	None Between 5%-9.99% 10% or more	2.15% 1.50% 1.25%	3.30% 1.50% 1.25%
Reserves/National Guard	None Between 5%-9.99% 10% or more	2.40% 1.75% 1.50%	3.30% 1.75% 1.50%

So let’s take a look at this ‘deal’ that is offered by the VA. If you take out a $150,000 mortgage, you will normally pay $1,500 for your origination fee to the mortgage broker. I would argue that you can do better, but not too bad and not the topic of this article.

If you get your mortgage through the VA however, which is still done through a lender, your closing costs would be higher. I’m going to use the same table above, but replace the percentages with the dollar amount based on a $150,000 mortgage amount to show you the total cost to get a VA no closing cost mortgage.

Type of Veteran	Down Payment Amount	First Time Use	Subsequent Use for Loan until 09/30/11
Active Duty	None Between 5%-9.99% 10% or more	$3,225 $2,250 $1,875	$4,950 $2,250 $1,875
Reserves/National Guard	None Between 5%-9.99% 10% or more	$3,600 $2,625 $2,250	$4,950 $2,625 $2,250

So if you add in the $1,500 the lender will charge you to originate the loan, you are looking at a minimum of $3,375 in closing costs. What the VA allows you to do though is finance you closing costs into the amount of your mortgage. So theoretically, you could be paying interest on that $3,375 for 30 years! Now those closing costs, if paid out over 30 years at today’s rate of 5% will cost you $3148.20 in interest! So in effect, you are paying $6,523.20 to take out the VA mortgage. This is also assuming the lowest funding fee charge, so really, for Active Duty members putting down 10% or more to purchase their house! So you can see how taking out the VA loan is actually quite expensive to do. If you could save money to put down on down payment or even to pay for your closing costs out of your pocket, that would be the best way to go.

Now granted, I realize that these numbers actually apply to those individuals who only take out that one mortgage and live in their house and actually pay off their mortgage at the end of that original 30 year mortgage. Statistics show us that this is not the case and that most Americans actually move approximately every seven years. Once you are in the house though, don’t spend the money on frivolous items, save the money for that house your going to purchase in the future. The best way to keep the money in your pocket is look for no or low closing cost mortgages.

As I have hopefully demonstrated above, the VA no closing cost option is really a misnomer because the cost is large, it is just hidden in 360 small payments in regards to the closing costs being financed into the 30 year mortgage and with interest charges over that long time period, the closing costs are almost double!

Another drawback to VA mortgages is because of the increased regulation for the guarantee of the loan by the federal agencies, mortgage lenders usually charge a higher rate for the same mortgage too. So not only are you paying for your closing costs over a long period and higher cost in the form of paying interest on your closing costs, you also are looking at paying a higher interest rate for that mortgage. The payments on a $150,000 5% mortgage is $805.23 versus the higher rate of a VA mortgage at 5.125% which is $816.73. That’s only $11.50 per month, but with 30 years of payments, that’s $4,140. If you throw in the interest expense for the closing costs being financed, your looking at over $7,000 in extra interest, just for the benefit of going with a VA no closing cost mortgage. For me at least, that is no good.

If your still active duty and will be PCS’ing approximately every 2-4 years, then PenFed’s 5/5 ARM would be the best way to go or another comparable ARM because you should theoretically be moving before the 5 year ARM adjusts.. The way it works is your mortgage your rate is fixed for five years and then it resets every five years. PenFed will also cover most of your closing costs so that your out of pocket expenses are minimal. That would be the best way to go, and then you could refinance, if you had enough equity, with a no closing cost mortgage.

Many states also have localized mortgage programs for residents of their states which can offer low interest rates, low closing costs, and other benefits that you won’t find with VA loans. They do of course come with stipulations like you cannot sell the house for a certain period of time, you cannot rent out the house, etc. Check in your state to see what programs are offered that you may qualify for.

As long as you have cash in hand for down payment or closing costs, that would be the best way to go because of the cost. And because of the nature of the Active Duty military and really, the way we Americans move around approximately every seven years, getting loans for with closing costs are a big drain on your personal finances and your cash pile.

I will include more information once I have more information, but Wells Fargo has a 1-2-3 No Closing Cost refinance mortgage available for existing customers as well non customers in which they will refinance your mortgage for no closing costs as long as you fit their lending requirements. I don’t know what their requirements are, however, this is my profile:

Credit Score: Over 720

Debt to Income: Less than 30%

Home Loan to Value: Less than 65%

If you fit this profile or are similar, it wouldn’t hurt to take 20 minutes of your time and see if you qualify. I can’t vouch for the program at this point, once I close on my mortgage I will write up an article on my experience.

As you can see, with good credit and cash in your pocket, you can get a no or low closing cost mortgage with minimal costs and not get ripped off with a VA mortgage. This would be the best way for your personal financial situation and allow you to ultimately get the best deal possible. Remember though, that lenders will try and get as much money from you as possible, so be prepared to shop around to find that mortgage deal. If a lender tries to pull a fast one by changing details of the deal at the last minute thinking you will still take that mortgage, then be prepared to walk, or be taken advantage of.

As this article shows, VA mortgages are not the a good deal for mortgages out there because of minimal or no closing cost mortgages through traditional methods available out there so that can acquire a no or low closing cost mortgage without going through a federal program that actually costs more than a conventional mortgage.

What is a no closing cost mortgage?

No closing cost mortgages are mortgages in which you do not have to show up at the closing table with any cash of your own. Usually, this is accomplished during a refinance, purchase mortgages can be setup to also be done as a no closing cost mortgage, it is just not as easily available for a purchase mortgage.

When I say no closing cost mortgage, that’s exactly what I mean. No origination points, no discount points, no fees what’s so ever. While the money the broker makes will still be the same, you are agreeing to take a higher interest rate to help pay those costs you normally would pay with a normal mortgage transaction. You will have to cover prepaid items however, like your prepaid interest to cover the interest cost until you make your first mortgage payment as well as the tax and insurance payment requirements if needed. These are not fees or costs, but they are normally covered when you make your monthly mortgage payment.

On a refinance, if your previous mortgage was holding your tax and insurance payments in escrow, while you would pay the escrow during your closing transaction, after the prior loan gets paid off and they process the payment, the old mortgage note holder will then usually issue a check to you with your escrow balance. So in the end, you only make a payment for the interest that would be owed between closing and your first mortgage payment.

As an example, if you close on your mortgage on the 15th of the month. The mortgage company is not going to let you have that money for free. So for the prepaid interest, you are actually making the interest payment from the 15th until the end of the month so that when you make your first mortgage payment, the interest has been covered with your prepaid interest. Needless to say, your going to pay for it one way or another, you just prepay it at the closing table.

When figuring out the interest rate for your mortgage, the bank or broker will have a rate sheet. What that sheet shows is the different interest rates the bank offers and how many points the different interest rates costs to get all the way to 0 points. On the other side of that 0 points however, are the points that a bank will give a broker to get the customer, that is you, to take a higher rate. So for instance, if 5.0% is zero points, well, then 4.75% may cost you 0.875% in points to lower your rate. On the flip side, if the broker can get you to take a 5.25% at 0 points, then the bank may pay the broker 0.25% of your mortgage.

For illustration purposes, this is what I mean.

Interest Rate	Points
4.75%	0.875%
4.875%	0.25%
5.0%	0%
5.125%	-0.125%
5.25%	-0.25%

So using the table above, you can see that for the higher interest rates, the bank will rebate money back to the broker for the higher interest rate. If you wanted a lower interest rate, you can see how much it would cost you as a percentage of your loan amount to get that lower interest rate. If you are dealing with a broker, the broker may change the figures above to allow them to make more money off of your mortgage.

Note: These numbers are just examples and therefore should not be taken as gospel, not to mention the fact that rates can and do adjust throughout a business day as well.

Now, how you can potentially get that no closing cost mortgage or refinance is, instead of taking the 5.0% 0 point interest rate, you could potentially take a 5.5% mortgage interest rate and the rebate is shared between you and the broker to lower you closing costs or give you that no closing cost mortgage your looking for. There are of course drawbacks to this option, you are paying a higher interest rate and therefore more in interest each month. If you are not going to hold the mortgage for a long period of time however, a no closing cost mortgage could potentially make sense. It limits your closing costs and it allows you to get a lower interest rate than what you may have been paying earlier.

The no closing cost mortgage also gives you the flexibility in a falling interest rate environment to refinance as much as you want because ultimately, you do not have to worry about closing costs and you don't have to concern yourself with payback periods because as soon as you make your first payment, you are saving money, unlike others who may have had closing costs. There are many different ways of acquiring a no closing cost mortgage as well. The statements I made above reference a typical mortgage that most everyone is aware of.

The other potential option is to get a Home Equity Loan, or HEL in industry parlance, offered by an institution with no closing costs. You use the proceeds of the HEL to pay off your traditional mortgage and the HEL then jumps into first position and you only pay the HEL as your monthly mortgage payment. As an example, Pen Fed currently is offering a no cost HEL for 4.99% on a 20 year payback period. This would allow you to get that potential lower interest rate for no cost.

You could also use the higher interest rate to get a lower closing cost with a shorter payback period instead of going with a true no closing cost mortgage. This still provides flexibility, but not as much flexibility as a true no closing cost mortgage would. So instead of paying 2-3 thousand in closing costs, you could choose the rate which allows you to pay for instance, only 1k in closing costs, in addition to your prepaid items.

The drawback to a no closing cost mortgage is you give up the ability to get the lowest interest rate and therefore pay less in interest and lower payments. For most people however, this should not be a problem seeing as how the average homeowner moves every six years per the National Association of Realtors. If you cannot break even prior to two years however, it would probably be best to limit your closing costs as much as possible. If you plan on staying in your house longer than two years, then it may make sense to pay closing costs and get that lower interest rate. If your not sure as I currently am, then stick with the no closing cost mortgage because it helps keep money in your pocket until you figure out what your going to do.

With a no closing cost mortgage, this allows you to keep money in your pocket and get a relatively good rate. Not necessarily the BEST mortgage rate out there, but it allows you to lower your rate for very little cost if you are looking at refinancing and lowering your payments. While a no closing cost mortgage will give you the lowest interest rate, the option does have it’s positive aspects and has a place when financing or refinancing your house.