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Should You Get a No-Closing-Cost Mortgage?

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If you’re looking to save cash when buying a home, a no-closing-cost mortgage could be a good option. You won’t need to pay out of pocket for all the traditional fees that come with a mortgage, like application fees and attorney fees. But that doesn’t mean you’re not paying for them at all: No-closing-cost mortgages typically charge higher interest rates — meaning you’ll pay the price in extra interest charges for the life of the loan.

What is a no-closing-cost mortgage?

When you take out a traditional mortgage, there are a whole host of fees and charges that you need to pay. However, many lenders offer what’s called a “no closing cost” or “zero closing cost” mortgage.

With these mortgages, you don’t have to pay cash at closing for any of the fees and charges you’d normally pay. However, you usually pay for them in one of two ways:

  1. Your lender covers the costs, but charges you a higher interest rate on the loan. With lender-paid closing costs, that means you’ll have a higher monthly payment for as long as you have the loan.
  2. The closing costs will be rolled into the mortgage itself, increasing the total balance. This, too, translates to a higher monthly payment.

Here’s the trade-off with zero-closing-cost loans: You save money upfront, but end up paying much more over time.

“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,” said Dan Estal, vice president of lending at Northern Credit Union, in Watertown, N.Y.

No-closing-cost loans are a common choice at his institution. The average customer at Northern Credit Union takes a $145,000 mortgage and pays about 3% of that in closing costs.

According to Estal, 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.

Still, other lending experts caution homebuyers that saving on closing costs today might cost thousands of dollars in extra interest over the course of a 30-year mortgage.

Only if a buyer plans to own a home short term does such a mortgage make good financial sense, according to David Demming, a financial adviser and mortgage originator in Ohio.

“If you are so sensitive in terms of paying money upfront, you probably can’t afford the home,” he said.

It’s important not to get fixated on a marketing label like “no closing costs” and instead have a dialogue with your lender, said Mark Kraft, a Colorado-based regional mortgage manager with U.S. Bank.

Looking at your credit score, savings and income, your lender should be able to come up with a solution, he noted. 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 that can cover closing costs.

How much are closing costs on a mortgage?

Mortgage closing costs, sometimes referred to as settlement costs, typically average from 2% to 6% of your mortgage amount. On a $250,000 loan, this means you’d likely pay between $5,000 and $15,000.

These closing costs can include:

  • Appraisal fees
  • Title insurance
  • Taxes
  • Homeowners insurance
  • Origination fees
  • Application fees
  • Processing fees

Your lender is required to give you an estimate of these closing costs within three business days of you submitting your preliminary mortgage application, and you find out the actual costs at least three days before you close on the mortgage.

Pros and cons of no-closing-cost mortgages

Pros

 You save cash upfront. If you’re buying your first home and don’t have a lot of savings, a no-closing-cost mortgage can help you close on the property without stretching your cash.

 You might be able to make a bigger down payment. Since you’ve freed up some cash, you might be able to make a larger down payment on your home than you would otherwise. This immediately gives you more equity, and could help you avoid paying private mortgage insurance (you’ll usually need to pay for PMI if you make a down payment below 20%.)

 You reach your refinance “break-even” point sooner. If you’re using a no-closing-cost refinance, it might mean you break even on the refinance sooner. The break-even point is when the amount you save in monthly payment by refinancing outweighs the initial costs of the loan.

Cons

 You might pay more in interest. No-closing-cost mortgages tend to charge a higher interest rate. This leads to a higher monthly payment for the life of the loan.

 You might have a larger loan. If your lender chooses to roll the closing costs into your mortgage, your loan balance will be bigger than it would be if you paid the closing costs. This also requires a higher monthly payment.

 You might face a prepayment penalty on your mortgage. Because lenders are eating the upfront costs, some will require you to pay a prepayment penalty if you choose to refinance within a certain period of time. This will increase your costs if you want to refinance to a lower interest rate down the line.

How to get a low-closing-cost mortgage

A no-closing-cost mortgage isn’t the only way to save some upfront cash when buying a home. Here are a few other options to consider if you’re looking for a low closing cost mortgage.

Negotiate with your lender. Closing costs aren’t set in stone. Many fees can be waived or reduced — especially application fees and origination fees that the lender charges. Explain your needs to your lender and ask if they can lower or remove fees. You may be able to reduce your upfront costs without adding to your interest rate.

Find a homebuyer program. Many cities and states offer first-time-homebuyer programs that include grants or other assistance for your down payment and closing costs. These can take the form of a no-interest loan or a forgivable loan. Many of these programs have income limits and other requirements, so be sure to read the fine print.

Ask the seller to cover the closing costs. Usually the buyer pays closing costs, but you can negotiate with the seller of the home and ask them to cover some of the costs. These are known as “seller concessions.”

 

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