The home purchase process is complex and requires the buyer to make a lot of decisions. It is easy to forget about mortgage closing costs and lending fees associated with home loans. In many cases, when you get to the closing table, you will get a bill that amounts to 3-6% of the loan amount. This does not include the fees for various services – appraisal, title search and deed recording. For a $200,000 mortgage, the third-party fees and origination costs come in at an average of $2,100. If you think you can use that money better for other things, or you simply lack the cash in your savings account, one option is to get a no closing cost mortgage. If you use a no closing cost mortgage smartly, it can save you thousands at the closing table. But for some buyers, the no closing cost mortgage can cost you thousands of dollars. It might even cost you tens of thousands of dollars than a loan with the mortgage closing costs paid up front. Below is more information about the pros and cons of the no closing cost mortgage.
When you buy a home it may benefit you to choose a no cost home loan with no mortgage lender fees or closing costs, but you have to evaluate several options and do the math before making a choice.
A Free Lunch – Temporarily
It is always instructive to remember there is no free lunch in life. This principle applies to no closing cost home loans, too. In most cases, you will eventually pay for the closing costs. You simply put them off to the future is all.
No closing cost mortgage loans usually are in two flavors:
- The mortgage provider adds the closing costs to the principal on the loan. This allows you to spread the closing costs over the loan’s life. The down side of doing this is your payment each month will be higher than if you paid the costs at closing.
- The lender also may cut the closing costs entirely but will charge you a higher rate for the life of the loan. This applies whether it is an original loan or a refinance. For instance, the lender could offer a rate of 3.5% if you are paying the closing costs and fees at closing. Or, they will charge a rate of 3.95% for eating the closing costs. In this case, the lender usually will more than recoup the closing costs with the higher rate over many years.
Depending upon how long you keep the loan and stay in the home, the no closing cost mortgage can cost you more, or cost you less. If you sell the home or refinance within a few years, you can save money. But if you stay in the house for many years and do not refinance, the higher rate or the higher principal will make your loan considerably more expensive than if you paid the costs at closing.
If you are considering using a no closing cost mortgage to save you money when you buy a home, you need to determine when you will break even. This is the number of months it will take you to recoup the costs from a regular mortgage.
To calculate this point, you can use a variety of online mortgage calculators. Also, you can ask your lender to give you a closing cost analysis. Further, you may ask about the difference in payments and interest rates for a no closing cost loan compared with a loan with the fees paid upfront.
After you have determined where you break even, you can look at that number and compare it to a no closing cost loan to determine in which time frame you would save and lose money. For instance, say you have two loan options for a $150,000 loan. One has a rate of 3.75% and closing costs of $3500. The other has a 4.25% rate and no closing costs. With the higher rate option, you will pay $43 more each month. That is $16,000 over 30 years.
If you opt for the standard mortgage and pay closing costs up front, you break even in under seven years. In this scenario, you save money only if you sell or refinance before seven years are up. Otherwise, you are costing yourself money.
Yes or No on a No Cost Refinance Mortgage?
A no closing cost mortgage with a higher rate could be a good choice for the person who is short on cash when buying a home. Or, perhaps you want to use that money to do some much-needed home improvements. If so, just know you are making a trade off. You will have lower monthly payments in exchange for a mortgage that costs you more over time. That is why most financial experts say if you can afford it, get a traditional mortgage and pay closing costs up front. The no closing cost mortgage can cost you many thousands of dollars over the life of the loan. But if it comes down to buying or not buying a home, or if you are sure you will move or refinance in less than five or so years, a no closing cost mortgage can work.
How to Refinance Your Home loan and Not Pay Any Fees or Raise Your Principle Mortgage Balance.
Do you want to refinance your home loan into a lower rate? Doing so may be able to save you a lot on your monthly payment. But taking out a new loan costs money; there are various fees that you have to pay to close the loan. These fees can add up to 3-5% of the loan amount.
What if you do not want to pay any fees and not add to the loan balance with a refinance? You may want to consider a no cost refinance that is offered by some lenders. What is that all about and what’s the catch? Keep reading to learn more about no cost refinances.
A no-cost refinance loan is a mortgage refinance where the lender or broker covers settlement fees, including common lender fees such as processing, underwriting, appraisal and loan origination points.
A natural question to ask is if the lender or broker is paying for these fees, how are they making up for this money they are spending? Nothing is free in this life. They make up for it usually by increasing your interest rate, sometimes by a good amount, to make up for the money they are paying for you to close the loan.
It is a very simple trade: You pay nothing now to refinance the loan, but you will pay more interest over the life of the loan for doing a no cost refinance. Note that the terms of a no cost refinance will vary by the lender. Some programs might cover all of the closing cost fees, but others could still charge you some of them, such as appraisal and inspection, title and escrow. For instance, if the bank is advertising a ‘no lender fees’ loan, this means you will be responsible for paying third party fees and also property taxes, interest and insurance.
Example: Let’s say you can qualify for a refinance at 6% interest on a loan of $500,000. You are paying a point to the lender and another $2500 for closing costs. The total is $7500 that you can pay up front when the loan closes. Or, you can have the lender cover the $7500 and it will charge you a 6.5% interest rate. You will pay nothing now but will pay substantially more in interest over the years. Whether this is a good financial move or not will depend on many factors.
Should You Refinance with No Closing Costs?
Generally, a no cost refinance can be a good move if you do not plan to be in the home or the loan for very long. If you plan to sell the home or refinance again within three or four years, a good argument can be made to save the out of pocket costs and do a no cost refinance. It usually takes several years to recoup the closing costs paid in a refinance.
Whether you should pull the trigger on this type of refinance or not comes down to what you plan to do with the home and mortgage in the next five to 10 years. If you want to move or upgrade to another home within four years, you could be well served with this option. And if you like to refinance every few years, paying up front costs for a refinance with a lower rate may not be a smart idea. Why pay for a lower rate if you are just going to refinance or sell in two years?
The problem comes in for people who are in the home for the long haul. If you are going to stay in the home for more than five years, you will be paying more interest each month for every month of the loan until it is paid off. This can add up to thousands in interest over the life of the loan.
The takeaway on no cost refinances is they are not inherently bad or good and they are not a scam. Every loan comes with closing costs. It is simply a matter of determining if you want to pay those costs now or over the years. The benefit or cost of each choice depends upon your financial circumstances and what your plans are for the home and mortgage in the next several years. Be sure you have done the math to determine which is the best for you.
Also, watch out for a bank that puts the closing costs into the mortgage. In this situation, the lender has not paid the fees for you and it is not really a no cost loan. You are paying the fees over the loans life instead of at closing and you have a higher loan amount on top of it all.