A small number of Washington area lenders have begun offering mortgage programs that eliminate some or all closing costs if borrowers are willing to pay for the service in higher interest rates and monthly payments throughout the life of the loan.
Rick Jenkins, loan manager for Douglas Michaels Mortgage Service Inc., said that his company started offering such a program two months ago. For one-half of 1 percentage point above current interest rates, the firm will pay all points and closing costs, which can amount to 2 to 3 percent of the sales price in Virginia and as much as 6 percent in Maryland.
Wye Mortgage Co. two weeks ago launched its own "closing cost eliminator" program and will pay increased amounts of closing costs depending upon the interest rate a buyer selects. David Hershman, Wye's vice president, said that his company will pay up to 5 percent of the loan amount in closing costs in exchange for an interest rate that would approach 13 percent -- nearly 1 1/2 percentage points above the current interest rates on fixed-rate mortgages. The only upfront payment the borrower would make is a 5 percent down payment.
Goldome Realty Credit Corp. also takes care of closing costs in exchange for charging the borrower higher interest rates, but "only if somebody requests this type of loan," said Rick Scott, an assistant vice president and branch manager of the company's Montgomery County office. Other mortgage companies eliminate loan origination fees, which can amount to 1 percent of the mortgage, but don't go as far as cutting such closing costs as attorney's and document preparation fees.
Borrowers with closing-cost-eliminator loans must still pay escrow items like property taxes and insurance premiums, as well as prepaid interest.
Although mortgage firms typically have cut discount points in exchange for higher interest rates and have allowed homeowners who are refinancing to finance settlement charges, doing so for closing costs and loan origination fees on first mortgages is a new trend that reflects the pressure on lenders to devise ways to attract borrowers in an increasingly competitive mortgage market.
As rates began to rise last spring, refinancings, which had constituted 30 percent of mortgage companies' business, plummeted. That, along with a 5.3 percent drop in existing home sales from levels of a year ago and increased competition among lenders, has cut some firms' loan volume in half.
Lenders like the closing-cost elimination plans because they cost the institutions nothing. "What they do is price the rate a little higher and the mortgage company makes out the same... , " Jenkins said. Lenders typically sell loans through secondary market mortgage companies such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp., which in turn sell groups of mortgages to investors.
But secondary market investors typically buy loans that have higher interest rates than those borrowers pay. To make up the difference, mortgage companies charge discount points -- each point amounts to 1 percent of the loan -- that they sell to investors along with the loan itself.
Conversely, by charging interest rates that are higher than the market average, lenders get money back, which they use to pay borrowers' closing costs, Hershman said. "In essence, lenders are getting points from the investor. And instead of crediting the money as profit, the lender uses it as a sales tool by paying the closing costs," said Goldome's Scott.
Jenkins said that the response to closing cost eliminator programs and zero-point loans has been good. "We're getting a lot of calls about our program. About 20 percent of the people have been asking about this type of loan," he said.
John Ruppert, a vice president and branch manager of Investors Home Mortgage Corp.'s Gaithersburg office, said the program "is good for a buyer who has the income, but is tight on cash" to make both the down payment and pay the closing costs. "It may make the difference between buying a house you otherwise might not be able to afford."
Jenkins noted that borrowers also could apply the money that they would have had to use for closing costs for a larger down payment, which would increase their equity in the property and would lower their monthly mortgage payments.
Despite the upfront savings, closing-cost elimination plans can prove costly. Home buyers who take out a mortgage at 11 percent on a $100,000, 30-year fixed-rate mortgage would pay $953 a month in principal and interest, Scott said. By comparison, borrowers with a 13 percent mortgage would pay $1,107 a month, a $154-a-month difference. After paying a mortgage for 33 months, a borrower would start paying back more than the amount he saved in closing costs, he said.
Ruppert said that a person who stays in a house for 15 or 30 years would end up paying much more in interest than he originally saved. And although mortgage interest is deductible, "it's still not a straight dollar-to-dollar return," he said.
But Scott noted that homeowners across the nation typically move every five to seven years, and every four years in the Washington area. Consequently, he said they would not live in their homes long enough to pay back too much more than they would have paid in closing costs.
Hershman's concludes that a closing-cost plan is "good for someone who will be in the house a short time. But it's not for everyone."