Explaining zero-cost refinancing

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Q:We live in Frederick, Md., and are considering a zero-cost

refinancing that we learned about through your column. We spoke to two banks, and both said they don't offer such a program.

One loan officer told me that it couldn't be done. Can you give a full explanation of how zero-cost refinancing works?

A: Certainly. I have done so in the past many times, and I'm happy to explain again.

First, zero-cost refinancing should not be considered a free lunch; we all know there's no such thing. The bottom line is this: In exchange for a slightly higher interest rate, usually one-quarter percentage point, a borrower can refinance his house without paying any closing costs. The costs are not rolled into the loan or paid out of pocket.

It doesn't surprise me that some banks don't offer such a program. The zero-cost concept became popular when mortgage brokers began using their "yield spread premium" to offset some or all of borrowers' closing costs.

Let me explain.

Mortgage brokers receive wholesale rates from lenders nationwide. When I say "wholesale," I mean that the rates offered to the broker usually are cheaper than what a consumer can get if he goes straight to the lender.

This is because the lender requires the broker to perform all the work to get the loan in approvable shape. This includes originating the loan, consulting with the client to find the most compatible program and processing the application package.

When the broker is finished, the lender receives a complete mortgage application package that's in full legal and underwriting compliance. The lender merely needs to sign off on the loan.