Mortgage Question

My mortgage automatically applies extra payments to the principal but I think those that don’t apply the payment to the next scheduled payment (which will often consist of mainly interest) That’s definitely what other loans do. For example, if there is a scheduled payment of $1000 on July 1 and I instead pay $1500 , only $500 will be due on August 1.

It doesn’t get applied to interest. It gets applied to the future. If I pay double in July, then I don’t have to make a payment in August. But I haven’t gotten any of the benefits of paying down early, chipping away at the compound interest snowball. With some lenders, you must specify that the extra money isn’t to go to the August payment, it’s to pay down the principal of the loan. Not a big deal.

That’s one question I had when reading up on this stuff recently: if you pay extra, does this mean your future payments go down but continue until the original end date, or do the payments stay the same and the end date moves up? It seems here in the Netherlands it’s mostly the former, but it’s often not specified.

The payments go down option is better IMO because you can always pay extra if you want and if you keep doing that you’ll pay of your mortgage earlier anyway OR you can pay less for a while after extra payments if that suits your needs better.

I agree with most of what the other posters have said. My vote is that in the long run you’ll be glad you refinanced at a lower interest rate.

Depending upon what state you live in, your current finance company might have an odd reason for wanting you to refinance. In California, a loan based on a note and deed of trust (commonly referred to as a mortgage) used to purchase a home is non-recourse. But when you refinance, the new loan is a recourse loan. If the mortgage company has to foreclose on a non-recourse loan they can take back the home and sell it but if the sales price falls short of what they are owed they cannot sue you for the difference. In a recourse loan, the mortgage company can sue you for the difference.

It is extremely unlikely that there are no closing costs for this refinance deal. Instead, what is typically the case is that the closing costs – a few thousand $$ usually – are being added to the principal you owe as of the date of closing, and being paid off in the same way and at the same time.

So, for example, if you owe $155,000 on the date of closing, and the real closing costs are $2500, a fairly typical number, then the loan you take out on the day of closing will be $157,500, payable over 30 years at x% interest. You will want to take that into account when you decide whether you’re saving money, over the short- or long-term (and usually those two goals are at odds).

This also tells you why the offer is made in the first place. Mortgage lending in the US is weird business these days. Few banks actually keep the loans they make, they are almost all immediately sold to Fannie Mae or one of the other big government backed mortgage holding companies. (The bank usually retains the servicing of the loan, so you write your checks to the bank, but the loan is actually owned by Fannie Mae et al.)

So what happens is your bank will borrow $155,000 from somewhere, then write you a loan for $157,500, then sell that loan to Fannie Mae. That leaves them with $2500 (the real closing costs) as profit on a pretty safe and easy transaction, less whatever their borrowing costs are for the $155,000 (and whatever of the closing costs represent payments to other vendors), and adding in whatever interest you pay before the loan gets sold. That’s why they make the offer. They actually don’t care very much about the interest rate, because they’re never going to see more than about 60-90 days of the interest on the loan before they sell it. So their financial motivation is actually to get you to refinance as many times as possible, since each transaction earns them a modest but reliable profit.

All of which suggests that a visit to a professional number cruncher, versed in local law,is essential before making a decision.

Here in the US the monthly payment stays the same and the required number of payments is reduced. There may be some exceptions but that’s generally how it works, unfortunately.

Also some lenders here do not automatically apply the extra payment toward the loan principal.

There is a procedure called recasting which is available (to a limited extent) in some mortgages. This is a recalculation of the monthly payment after a large payment against principal. I am in the process of getting a mortgage which allows a one-time recast for a $100 fee.

I noted before that…

But people are saying things that might make it worthwhile for understand these concepts better. I am greatly simplifying this discussion so please don’t nitpick about inaccuracies in the edge cases or where I failed to perfectly qualify my statement. I’m afraid this will get confusing enough without bogging the discussion down further.

Actually, it’s very common for mortgage brokers to offer a no-closing cost mortgage. Here’s a cite to the fact that they exist: The rest of your post actually makes it clear why they would do that.

This is one way to offer a no-closing cost loan but it’s just as likely these costs are being waived in exchange for a higher interest rate. Without going into great details, let’s just say that the Truth in Lending Act and various anti-fraud statutes discourage mortgage brokers from saying they will offer a no-closing cost loan and then charging a bunch of closing costs.

CarlPham is right that few people offering loans (I won’t call them banks – most of them aren’t) actually keep the loans that they offer. That’s because the industry has found it to be more efficient to separate the mortgage origination, mortgage lending, and mortgage servicing functions. Generally, a mortgage in the U.S. will have three different companies doing each of these tasks. Most mortgages are also be insured which involves yet another company. I’ve never had a mortgage that didn’t have separate companies doing the mortgage origination, lending, servicing, and insurance.

A new mortgage starts with mortgage origination, that is finding a person who wants to borrow money, either to buy a house or to refinance an existing mortgage. The people who find borrowers and originate mortgages are generally called mortgage brokers. Mortgage brokers advertise mortgage rates, send out postcards to try to get people to refinance, and network with real estate agents to find borrowers. It is probably a mortgage broker who contacted Southern Yankee to try to get him to refinance.

Once the borrower has decided to get a mortgage, the mortgage broker will collect the application and other necessary documents from the borrower, and get the loan approved by an underwriter. The mortgage broker’s underwriter reviews the application and documents to make sure that that the loan will be easy to sell to a mortgage lender.

The mortgage lender is the person who actually has a big pool of money that it wants to lend to borrowers for 30 years. The mortgage lender wants to make sure that the loan is safe and that it will be repaid. One way the underwriter can convince the mortgage lender that the loan is safe is to have it insured. Generally, the mortgage broker can get safe mortgages insured by Fannie Mae or Freddie Mac. These companies will generally insure mortgages to borrowers with good credit ratings, for houses that you can live in today, when the mortgage is less than $417,000 and when the borrower has 20% equity in the property. These types of mortgages are referred to as “conforming mortgages.” If Fannie Mae or Freddie Mac agrees to insure the mortgage, they will guarantee that if the borrower defaults, they will repay the mortgage debt to the mortgage lender. An insured mortgage is at least as safe as Fannie Mae and Freddie Mac, which is very safe.

The mortgage broker can make money on loan by (1) charging the borrower a loan origination fee, (2) selling a loan to a mortgage lender for more than it paid for the loan, or (3) some combination of these methods. Mortgage lenders want safe loans that pay high interest rates. If two loans are equally safe, they will pay more money for the higher interest rate loan. Thus, mortgage brokers get the most money for arranging the highest-rate, safe loans they can arrange.

One way to get a borrower to agree to a higher interest rate is for the mortgage broker to offer to pay for all the closing costs of the loan. This is what I think Southern Yankee’s mortgage broker is doing. It will recoup the money it invests in closing expenses when it resells the loan with a higher interest rate at a higher price to the mortgage lender.

This is the other possibility – that the mortgage lender will just roll the closing costs into the new mortgage balance. The closing costs and the new mortgage balance should be disclosed on the HUD-1 statement. I would urge Southern Yankee to look at that document closely to understand what fees the mortgage broker is charging.

But real no-closing cost mortgages are quite common and I think it’s more likely that they will offer a truly no-cost mortgage at a higher interest rate than Southern Yankee could otherwise get. This is why it pays to shop around. Southern Yankee may find it better to pay the closing costs himself and get a better rate, or he may find a no-closing cost mortgage like he is being offered now with a lower rate. The longer he stays in the house, the more he is likely to benefit by paying the closing costs up front and getting the lower interest rate.

They might have this reason, but I seriously doubt it. As you note, it is true that in some states, acquisition mortgage debt is non-recourse whereas refinancing debt is recourse debt. That would mean that if Southern Yankee refinanced, he might be replacing non-recourse debt with recourse debt, which is a little riskier for him if he defaults. This would theoretically benefit the mortgage lender but, the truth is, no one involved in the decision to offer Southern Yankee a new mortgage benefits in any real way from converting non-recourse debt to recourse debt. This is because of real-world facts you neglect to mention that eliminate any motive:

(1) The mortgage lender isn’t the one offering to refinance the debt – a mortgage broker is doing that. The mortgage broker doesn’t hold Southern Yankee’s debt now and it won’t suffer any loss if Southern Yankee defaults. The mortgage broker doesn’t care if Southern Yankee defaults and so it doesn’t care at all whether his debt is recourse debt or non-recourse debt. It just wants to profit by arranging as many profitable mortgages as it can.

(2) The mortgage lender might prefer to hold recourse debt rather than non-recourse debt to theoretically increase its chances of recovery but, if the loan gets refinanced, the mortgage lender will be repaid in full today and it won’t hold any debt at all. In fact, the refinancing will cause the mortgage lender to lose its real opportunity – to collect interest for 27 or so more years. Worse yet for the lender, if Southern Yankee does refinance this loan right now at a lower interest rate, the mortgage lender will get all its money back at a bad time because it will have to reinvest those mortgage proceeds at those lower interest rates (whether to Southern Yankee or someone else). Trust me, a rational mortgage lender would much rather continue to collect 27 more years of mortgage payments at the higher rate than convert its mortgage to recourse debt at a much lower rate.

(3) Chances are, Southern Yankee’s mortgage is insured and if he defaults, the insurance company will pay the mortgage lender for any gap that isn’t recovered in the foreclosure auction, so the mortgage lender is probably completely indifferent to whether the debt is recourse or non-recourse. The insurer might care but it prices its insurance based on its expectation of loss on the loan. Its expectation of loss takes into account whether the loan is recourse or non-recourse, so, in the end, even the insurer doesn’t really care that much whether the debt it insures is recourse or non-recourse.