Mortgage lenders make money even without fees

Q: My mortgage company has sent me letters asking me to refinance a 30-year loan with a rate of about 6.875 percent, which I've paid about 2 ½ years on. The new offer is supposedly at no cost to me, with a rate of 5.99 percent for 15 to 20 years. However, I will not have an escrow account and I'll have to pay taxes and insurance on my own. Is it possible for a company to refinance without charging the customer? How are they making money?

A: Mortgage companies don't have to charge you money directly to make money writing a new mortgage. They can make money by selling you a mortgage whose interest rate is over the market rate.

Then they can sell the mortgage for a premium over its face value. They can also simply hold the mortgage and earn the over-market interest.

You should also check whether the mortgage is offered at literally "no cost" to you or just "no out-of-pocket cost" to you.

Lenders will often add the cost of writing the mortgage to the amount borrowed. In effect, you are borrowing the cost of writing the mortgage and paying for it over 30 years.

Recently, for instance, the national average rate for 30-year mortgages was 5.63 percent, while the national average rate for 15-year mortgages was 5.21 percent — both higher than when you sent your question.

The difference between those rates and 5.99 percent would cover the expenses of writing a conventional loan, assuming good credit.

Be glad you don't need an escrow account. You'll earn the interest on the money.

Q: I'm married with a nonworking spouse and two children (12 and 10). I'm 41. My firm does not have a 401(k) or other retirement plan.

I take a relatively small draw and very large year-end bonus. The draw doesn't come close to covering my (admittedly large) living expenses, so I keep a large amount in cash.

Due to an expensive house and bad past investing, I've started each of the past three years with about 60 percent of my investments in cash. The other 40 percent is in equities split between two IRA accounts and two taxable accounts.

The cash is in a money-market fund that had an annual percentage yield during the last statement of 1.7 percent. I'm thinking of switching to the Margarita Portfolio, and I have a few questions.

First, since I have to keep so much in cash, can that cash take the place of an intermediate bond or an inflation-protected securities investment?

If so, I could invest the remainder 50/50 in a total stock market and total international fund.

Second, is there some place I can park some or all of the cash that is very liquid and has no capital risk but has a better return?

Third, does it make any difference what goes into IRAs versus what goes into taxable accounts?

A: How much cash we keep on hand depends entirely on the security of our income.

People who are self-employed or who work in sales have neither security nor income stability. They need to do what you do: hold more cash.

In fact, you use some of your cash during the year. That cash is part of your job, not part of your long-term investing.

Holding cash was painful last year when money-market funds paid practically nothing. Today, you could increase the under-2 percent return of the typical money-market fund by investing some of your cash reserve in a two- or three-year "ladder" of U.S. Treasury securities.

You would have some risk, since interest rates are rising, but you would sell the shortest maturity first in event of need.

Recently, for instance, two-year Treasury obligations were yielding 3.87 percent. With six-month Treasury obligations yielding 3.18 percent, you have a built-in "cushion" of 70 basis points against further rate increases.

Cash you expect to use during the year should be in a taxable account. Also, have a preference for equities in taxable accounts, fixed income in tax-deferred accounts.