The no-cost mortgage, extremely popular the past two years, may become an endangered species.
"No-cost refis are a victim of their own success," said Keith Gumbinger, a mortgage analyst at HSH Associates, a New Jersey firm that tracks mortgage rates for consumers. "Lenders made them so easy and painless to get that people wanted more than one. Every time rates go down, borrowers go back to the lender's office for another no-cost refi."
And each time a borrower refinances just a year or two into their old loan, the lender loses.
With no-cost loans, consumers can get a loan with no closing costs or points. In return, the borrower pays a rate slightly above the market rate -- usually about one-half of a percentage point, known as a "premium."
"When you do a no-cost deal, you're expecting the loan to be on the books for a while," said Richard Cermak, a loan officer at the Towson office of GMAC Mortgage Corp. "The idea is that you lose a little money at the beginning but make it up in the long run. If the borrower pays the loan off early, the lender is going to lose on that deal."
It usually takes at least two years for a lender to recoup his initial costs, Mr. Cermak said. And with the recent wave of people who are refinancing over and over again, lenders have become cautious about offering no-cost loans.
"Some lenders are backing away from the zero-cost program," says Charles "Chic" Reid, president of the Maryland Mortgage Bankers Association.
A majority of mortgage loans are sold by lenders to investors, often via government corporations such as Fannie Mae and Freddie Mac. It's these investors who stand to lose the most when a mortgage borrower pays his loan off early -- either through a home sale or refinance, Mr. Cermak said.
"No-cost refis encourage people to keep refinancing over and over again, and that makes investors very unhappy. Every time a borrower refis, an investor somewhere gets hurt because the yield on his mortgage-backed security declines somewhat," said Havemann.
Because the secondary market determines what type of loans lenders offer, Mr. Havemann predicts a gradual reduction in the number of lenders willing to make no-cost mortgages.
Brian Chappelle, of the Mortgage Bankers Association in Washington, predicted that many lenders -- instead of dropping no-cost loans -- would begin to offer them at much higher rates to discourage their use by consumers. The rate could be a full percentage point -- instead of a half -- above the market rate.
"They'll charge a 'premium-premium' rate that makes borrowers look at other products," Mr. Chappelle said. In other states, lenders also may impose penalties for loans that are prepaid -- paid off before the term. In Maryland, such penalties are illegal.
Several local lenders, who tout their no-cost mortgages, said they will continue to offer the product without raising the premium.
"We really think it's a loan for the '90s," said William Teal, Timonium branch manager for Norwest Mortgage, the Des Moines-based lender that was one of the pioneers of the product.
The company says it does not fear prepayments because it was willing to lose a little money in return for gaining market share.
Although popular with those refinancing their mortgages, the no-cost product also has a strong following among homebuyers -- especially first-timers -- who are short on cash, Mr. Teal said.
"It allows all the would-bes and could-bes to get something today," the Norwest manager explained, "rather than waiting until tomorrow to accumulate the cash."