The Truth about No Closing Cost Mortgages
The Truth About No Closing Costs Mortgages
You hear about them on the radio all day long. "We'll do your mortgage with no closing cost!" And you think to yourself, "Hey, that a good deal." Well you know what the wise man say, there is no such thing as a free
lunch. There is always a catch.
No closing cost mortgages are not a new concept. Mortgage brokers have been doing them for years. It is a perfectly legal way of doing business, so long as the borrower understands exactly what they are agreeing
to. The way this works is the borrower agrees to accept a higher interest rate than they would normally qualify for in order to not have the pay any of the closing costs. The broker earns what is known as "yield
point spread" or YSP for originating the loan at the higher rate and then simply pays for the closing costs out of their commission, leaving enough left to make doing the loan worth their time. The real winners in this
scenario are the lenders, who are now making considerably more money off of the loan in interest.
Now this strategy is a good one for borrowers who are not going to hold that loan for very long. Landlords or real estate investors who only plan to hold a property for a year or two, might find it worth while to take
the higher payment and interest rate to keep from having to put out $4000 or more every time they do a mortgage transaction. Likewise for military or corporate individuals who move around every few years.
However for the average homeowner, who may keep a loan for 10, 15, or even 30 yrs or more, this strategy doesn't make much financial sense. Let look at the following example.
Take a $150,000 mortgage where the borrower qualifies for an interest rate of 7.0% The closing costs for the mortgage will be $6,000, however this borrower is offered a no closing cost deal at 8.25% interest. Now
our borrower plans to live in this house and keep this loan for at least 10 to 15 years until all of his children have gotten out of college. He could certainly use that $6,000 towards things for his family and so the deal
sounds appealing. But let's see what his benefits would be (if any) for accepting the no closing cost deal.
Option #1
Loan Amount: $150,000
Closing Cost Paid: $6,000
Interest Rate: 7.0%
Loan Term: 15yrs fixed rate
Monthly Payment: $1,348
Total interest over the life of the loan: $92,684
Option #2
Loan Amount: $150,000
Closing Cost Paid: $0
Interest Rate: 8.25%
Loan Term: 15yr fixed rate
Monthly Payment: $1,455
Total interest over the life of the loan: $111,938
By accepting the no closing cost deal, our borrower would be paying $107 more a month in a monthly payment and over $19,000 more in interest over the life of the loan. All to keep from having to make a $6,000 investment in his home when he bought it. Had he paid the closing costs upfront and taken the loan at 7.0% interest, then he would have made back his initial investment in about 57 months.
So is a no closing cost mortgage right for you? That's up to you and your current situation. Just understand that there is no free ride. You are paying for it, one way or another.