No Closing Cost Mortgage Loans
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Closing costs can be a real hurdle, especially if you’ve just scrimped and saved enough to put together a down payment on your dream house. A mix of fees and taxes, closing costs are typically either due in cash when you close on your new home. A survey from real estate data provider ClosingCorp found that Americans paid an average of $4,876 in closing costs in 2017, but the total amount can vary greatly by region and by lender. In some cases, charges and taxes can add up to more than $10,000.
- Common closing costs include the following:
- Appraisal costs
- Tax service provider fees
- Title insurance
- Prepaid costs, including property taxes, homeowner’s insurance and early interest charges
The mortgage lender might also add hefty origination, application or banking charges, which can further increase the closing costs.
No closing cost mortgages
Many lenders offer what’s called a “no closing cost” or “zero closing cost” mortgage. With these mortgages, the lender will front many of the initial closing costs and fees, while charging a slightly higher interest rate over the duration of the loan. Once you are in your home, you’ll pay a larger monthly payment. The idea is that you don’t have to pony up as much cash upfront, when you are also putting up a down payment.
It sounds like a great deal, right? But be cautious if you’re considering this loan option because it can add significant costs to your loan over time.
No closing cost loans are a common choice at Northern Credit Union, in Watertown, N.Y., according to Dan Estal, the bank’s assistant vice president of lending. The average customer at Northern Credit Union takes a $145,000 mortgage and pays about 3% of that in closing costs.
He said it’s hard for a lot of first-time buyers to come up with enough cash to cover all the initial costs of homebuying. These mortgages help with that challenge.
“If your goal is just to get into your new dream home, especially as a first-time buyer and you don’t have the money saved, that’s the way to do it,” Estal said.
The decision for most people, he said, hinges not on the higher interest rate but whether they need the extra costs covered now in order to get the home.
Other lending experts cautioned homebuyers to remember that the upfront savings will cost them in the long run.
David Demming, a financial adviser and mortgage originator in Ohio, said it’s important to consider not just the upfront charges but the totality of costs.
Saving on closing costs today might cost thousands of dollars in extra interest over the course of a 30-year mortgage, which he outright characterized as a “dumb decision.” Only if a buyer plans to own a home short term does such a mortgage make good financial sense.
Demming also believes that first-time homebuyers who don’t have enough savings to cover closing costs might need to rethink whether the purchase is really a good idea.
“If you are so sensitive in terms of paying money upfront, you probably can’t afford the home,” he said.
Mark Kraft, the regional mortgage manager for Colorado and Utah at U.S. Bank, believes it’s important not to get fixated on a marketing label like “no closing costs” and instead have a dialogue with your lender. Looking at your combination of credit score, savings and income, he said the mortgage provider should be able to work with you and your needs. That process may result in finding the type of mortgage that works for you or helping you put on the brakes and come up with a savings plan.
No closing cost vs. traditional mortgages
Let’s compare overall costs on a traditional mortgage versus a no closing cost option.
Say you want to borrow $250,000 to buy a home and are looking at 30-year, fixed-rate mortgages.
Lender A is offering a traditional mortgage with 4.5% fixed interest rate and $3,000 in upfront closing costs.
Lender B is offering a no closing costs mortgage, with a 5% fixed interest rate and zero closing costs.
The monthly payment on Lender A’s loan is $1,266.71. On Lender B’s option, it’s $1,342.05 or $75.34 more each month.
If you choose Lender B, after a little more than three years of payments, you’ll break even with the bank, paying back the $3,000 in costs the lender paid upfront. After that, the bank will be making an extra $75 off your loan because of the higher interest rate.
If you keep the mortgage for the full 30-year term, you will end up paying the bank $24,000 more than with the traditional mortgage.
Of course, some homebuyers aren’t planning to stay in the same property for decades. The shorter the mortgage, the less the total cost of that higher interest. For example, if you choose Lender B and only stay in the home for five years, the added interest from the extra $75 monthly payment will total around $4,520. So you would only have paid the bank about $1,500 extra for covering the closing costs upfront.
Estel said homebuyers with no closing cost loans can also always refinance after a few years, especially if they plan to make home improvements. Still, there is no guarantee that future financing conditions will be better than the current ones. Interest rates could turn out to be higher down the line and property values could become stagnant or decline, making it risky to depend on the idea of refinancing later.
Important questions to ask
Each lender’s definition of “no closing cost” is slightly different. When shopping for a mortgage, it is important to find exactly what charges the mortgage provider will be responsible for and which ones will still fall to you. Even if it’s advertised as “zero closing cost,” most lenders still won’t cover specific taxes, insurance premiums or attorney fees. Things like flood insurance, private mortgage insurance and transfer taxes are often excluded from the deal.
Don’t get taken in by the marketing. Ask your lender at the start for a detailed list of which fees they’ll cover and which ones they won’t.
Another potential pitfall to watch out for: early repayment or cancellation fees. Some lenders require you to keep the mortgage for three years, or pay a penalty. Others might ask borrowers to repay the closing costs if the loan is closed too quickly. For example, Tioga State Bank advertises a “no closing cost” mortgage, but states if it is closed or discharged within three years, the borrower is responsible for paying back the waived fees. Another possibility is that a lender will charge a prepayment penalty for making payments ahead of schedule.
Such policies are to protect the bank’s profit and ensure they recoup the money laid out to cover the initial closing costs. Be sure to ask about this when negotiating loan.
Alternative low-cost mortgage options
Even if saving enough to cover a down payment and closing costs is difficult, a no closing cost mortgage may not be the best option.
For eligible veterans and service members, VA loans offer competitive interest rates with little or no down payment. FHA loans — backed by the federal government — require down payments as low as 3.5%. Explore your options before deciding a no closing cost loan is the way to go. Check out our list of low and no down payment mortgage options.
Keep in mind that closing costs are not set in stone. Many fees can be waived or reduced by lenders. This particularly applies to application fees and origination fees charged by the lender itself. Consider these charges negotiable. Explain your needs to your lender, ask if they can lower or remove fees and you may be able to reduce your upfront costs without adding to your interest rate.
The bottom line
If you are short on savings, no closing cost mortgages can help get you into a new home, but it’s important to understand you will pay more over time. The higher interest rate on these mortgages may not be that big of a deal if you only plan to stay in the home for a few years, but they could cost you thousands or even tens of thousands of dollars over the length of a 20 or 30 year mortgage.
Consider if it’s worth delaying your purchase in order to save enough to pay the closing costs upfront or, if you want to buy right now, going with a less expensive choice. It’s important to think about your long term financial strategy and what choice makes sense in light of your goals.
Jane Nowak, a financial adviser, says the need to save for down payment and closing costs slows down impulsive home buying and reduces people’s tendency to buy
more home than they can really afford.
However, if you’ve found the perfect home right now but are short on savings, and you can afford a slightly higher monthly payment, a no-closing costs loan can get you over the first hurdle. They also make more sense if you plan to only stay in the home a few years or to refinance quickly.