I have written before about the hazards of refinancing with your current lender, but the hazard you raise has only recently appeared in my mailbox. It has impelled me to set down in a more organized way the pros and cons of refinancing with your current lender.

The Pros

Perhaps the major reason people approach their current lender is that it is convenient. They are spared having to decide who and where to shop. If their payment record has been good, furthermore, their existing lender has immediate access to their record, where other lenders would have to investigate. There is comfort in "being known", and a belief that this should earn them special treatment.

There is some validity to this belief. The current lender – defined as the firm to which you now remit your payments -- may be in a position to offer lower settlement costs than a new lender. How much lower, however, can vary from case to case.

The greatest potential for lower settlement costs arises where the current lender was the originating lender and still owns the loan, a common situation with loans made by banks and savings and loan associations. If the payment record has been good, the current lender may forgo a credit report, property appraisal, title search and other risk control procedures that are otherwise mandatory on new loans. This is strictly up to the lender.

If the current lender was the original lender but later sold the loan and is now servicing it for the owner, the potential for lower settlement costs is less. A lender servicing for others must follow the guidelines set down by the owner. If the owner is one of the Federal secondary market agencies, Fannie Mae or Freddie Mac, the guidelines are theirs. While both agencies have provisions for "streamlined refinancing documentation", the discretion granted the lender, and therefore the potential cost savings, is quite limited.

The potential for lower settlement costs is least when the current lender was not the originating lender and is not the current owner. This is a fairly common situation that arises when the contract to service the loan is sold. In this case, the lender may not be in a position to use all of the streamlined refinancing procedures because its files do not contain some of the information those procedures require, such as the original appraisal report.

The Cons

The major argument against refinancing with your current lender is that that lender may not give you the market price. It will try to minimize its loss by taking advantage of your preference for staying put, and your reluctance to shop the market. Any settlement cost benefits your current lender can offer that other lenders cannot may serve to draw attention away from the fact that the rate and points offered are not competitive

Above-market offers are especially likely if the lender takes the initiative in soliciting its own customers. Lenders who do that are likely to base their offer on the borrower's existing rate. For example, in a 5% market, the borrower with a 7% mortgage might be offered 6% while a borrower with a 6% mortgage (but who is otherwise identical) might be offered 5.5%. The objective is to provide a saving over the existing loan that is attractive enough to discourage the borrower from looking elsewhere. This way, the lender gives up as little as possible.

The unfortunate borrower who wrote the letter above points up an even greater hazard: the borrower dealing with his current lender may get the run-around because that lender has no interest in completing the deal. Why rush to convert a 7% loan into a 5.5% loan? Charging a lock fee and then letting the borrower dangle is particularly vicious.

The Preferred Strategy

• Take a no-cost refinance when you expect to be in the house for a long time.
• Measure the cost of a cash-out refinance with the APR.
• Refinance into a biweekly at a higher interest rate for the purpose of reducing total interest payments.