When someone is getting a bit more serious about buying a home or refinancing an existing mortgage, the next step is typically to get a rate quote from a mortgage company. Because lenders set their interest rates on the very same set of indices, these rates will be very close to one another. In fact, when getting rate quotes, it’s not surprising that most of the lenders quote the very same rate for that day. But consumers must also compare the closing costs that go along with the quoted rate. While lenders don’t have any control over third party charges such as title insurance or attorney fees, they do indeed control their fees. An underwriting fee or a processing fee would fall into that category. When two lenders quote the very same rate, often it’s the difference in lender fees that points the borrowers in the right direction.
Every mortgage has closing costs, both from the lender and third parties. But what about those so-called “no-closing cost” loans that borrowers hear about? Why wouldn’t someone go with a lender that doesn’t have any fees. I mean, that’s common sense, right? But there are fees on all loans, it’s just a matter of who pays for them. Maybe the seller agrees to pay for the buyer’s fees. That however is not what a no-closing cost loan actually is. When a lender talks about a no-closing cost loan, it’s a function of the interest rate and the loan amount.
First let’s take a look at a sample rate on a 30 year loan at 3.75%. The rate quoted by the lender requires one discount point, or 1.00% of the loan amount. On a $200,000 loan that point is $2,000 and is the amount needed to get the 3.75% rate. Borrowers can choose to “buy down” that rate even further by paying more points. Points are a form of prepaid interest to the borrower and quite frankly the lender doesn’t really care if you pay any points at all. The lender gets the interest over the short term with a lower rate and a point or gets the interest over the long term. A lender might quote 4.00% without any points but in both scenarios there are closing costs to address, both from the lender and third parties.
The lender can quote various rate and fee combinations but to get at the no-closing cost option, the lender will adjust the interest rate upward even more. Perhaps the lender could quote 4.25% and also provide a lender credit of 1.00% of the loan amount.In this example the lender would pay $2,000 of the borrowers closing costs. The monthly payment will be slightly higher, but the borrowers didn’t have to come up with $2,000 in cash to close or roll the costs into their new loan amount if refinancing. You’ll also note here that the greater the loan amount the greater the credit. A 1.00% lender credit on a $400,000 loan is $4,000. Same rate but a bigger credit. That’s why no-closing cost loans rarely work with smaller loan amounts.
The tradeoff is higher monthly payments because of the higher rate and lowering the amount of cash at the settlement table. For someone planning on living in the property for the long term, it probably doesn’t make sense to take out a no-closing cost loan due to the higher rate. For someone who plans on keeping the property for just a few years, then a no-closing cost loan might be an option.
When you hear the term no-closing cost loan, remember that all lenders can offer them. But there are always costs and those costs will be reflected with a higher monthly payment for as long as you keep the loan.
