What Does a 'No Closing Cost' Loan Really Cost

Written by Posted On Monday, 13 June 2022 00:00

You've certainly heard the advertisements about getting a mortgage with no closing costs. Sounds like a no-brainer, right? I mean, if you can get a mortgage without having to pay various lender and third party fees, who wouldn't? Well, a no-closing cost loan really does have a cost, just not in the way many might think.

First, we need to recognize there are two types of costs at play here. There are recurring and non-recurring costs. Recurring costs are those that will happen again, over and over. These costs are items such as property taxes and homeowner's insurance. No-closing cost loans generally don't include recurring costs, although they can. Non-recurring closing costs are those that will happen with the purchase or refinance transaction. These kinds of costs are lender fees such as loan processing, document or underwriting fees, among others. It's this group of fees that are typically lumped into the no-closing cost loan category.

Lenders in effect don't pay the borrower's closing costs in such a transaction. The borrowers do in the form of a rate adjustment. Lenders can offer a range of interest rate choices for the very same program. If a borrower wants to get the lowest rate available, the borrower pays discount points, or simply 'points.' A point is expressed as  a percentage of the loan amount. For a 30 year fixed rate program, a borrower might want to pay a point to lower the rate. One point might lower the rate by 0.25%. For a $300,000 mortgage, one point is $3,000. You need to talk to your loan officer about your various rate and fee combinations.

But just as you can pay extra to get a lower rate, you can pay a higher rate and the lender will then offset the closing costs with a higher rate. The lender really doesn't care if you pay points or not. The lender either gets the interest paid over the life of the loan or can get an upfront point paid. The point is in fact a form or prepaid interest.

That's how a no-closing cost loan works. There is a cost, it's just expressed as a higher rate. You can make the choice whether or not to pay points or no points or get an even higher rate and have your closing costs paid at the settlement table. When you hear a lender talk about a no-closing cost loans, this is what they're talking about.

Your loan officer can help walk you through the process of evaluating all your rate and program options. Sometimes paying a point helps, sometimes it really doesn't matter. But again, the lender doesn't care, it gets its money one way or the other. Just don't be misled by the term 'no-closing cost' loan because there are indeed costs. There are costs on every single transaction. It's just a matter of how and who pays those costs.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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