If you haven’t heard that one before, you’ve likely seen or heard some variation of no closing cost loans advertised. Can a mortgage company really offer mortgages with no costs? The answer is yes and no.
With rare exception, anytime money is borrowed, someone gets paid. In order to get a mortgage loan to the closing table, items such as flood certification, appraisal, credit report, title/attorney fees, to name just a few are all necessary. In addition to being necessary, very few of these items (if any) come without cost.
These costs don’t just go away, your lender may be kind enough to pay them for you if he/she can make enough money elsewhere. Have you guessed where the elsewhere is yet? Unless you said interest rate, you didn’t guess correctly. A no cost loan is essentially a loan transaction in which the lender pays the closing costs for you.
So why would a lender pay a customer’s closing costs? Easy – most lenders will gladly pay your closing costs as long as you’re okay with paying a higher rate, generally .25 to .5 percent higher. The lender earns a premium by charging the higher rate. This premium allows the lender to pay the closing costs associated with the loan.
Typically, there are three types of no cost mortgages:
- No discount points but you pay both the lender fees as well as the third party fees.
- No discount points or lender fees – you pay all third party fees and a slightly higher rate.
- No discount points, lender fees or third party fees – you pay a higher rate.
With this in mind, it’s important to get clarification on how the lender defines “no costs”. You should certainly ask the lender to define their version of a no cost loan, leaving nothing to chance.
Could a no cost loan be right for you? Maybe. A no cost loan is actually a really good alternative for those who know for sure they’ll be paying off their loan within a year or two. Conversely, if you plan on staying in your home and never refinancing, the higher rate will end up costing you more over the life of the loan.
To find out what type of loan is best for you, speak with a knowledgeable lender that will guide you through the anatomy of a mortgage. The right lender is the key to understanding the correlation between interest rates and closing costs. The better you understand the components of a mortgage, the better you can feel about making the best possible informed decision for both you and your family.