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Should You Get a No-Closing-Cost Mortgage?

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If you’re looking to reduce the amount of cash needed for a home purchase, a no-closing-cost mortgage could be a good option. You won’t need to pay out of pocket for all the fees that traditionally come with a home loan, like origination, title or appraisal fees. However, a no-closing-cost mortgage often comes with a higher interest rate to offset those costs, which means a more expensive mortgage payment and increased interest charges over the life of the loan.

What is a no-closing-cost mortgage?

With a traditional mortgage, the fees and charges known as “closing costs” usually have to be paid by the time you close the loan. Since these closing costs can total thousands or tens of thousands of dollars — and are usually paid in cash — some homebuyers are looking to avoid them. To cater to these buyers, some lenders offer what’s called a “no-closing-cost” or “zero-closing-cost” mortgage.

With these loans, you don’t have to pay cash at closing for any of the fees and charges you’d normally pay. However, it’s important to understand that you’re making a trade-off, not getting a true discount. You’ll still pay for them in the long term. The question is, how?

How does a no-closing-cost mortgage work?

There are generally two ways a no-closing-cost mortgage works:

  1. You roll the closing costs into your mortgage. Instead of paying closing costs in cash up front, they are added to the mortgage, increasing the total loan balance. This will make your monthly payment higher, but it will free up the cash you would’ve used for closing costs.
  2. Your lender covers the closing costs but charges you a higher interest rate. You’ll save money now, but a higher mortgage interest rate will yield a higher monthly payment for as long as you have the loan. This is very similar to a “buy-up” or lender credit, except that these options may be for a flat amount, rather than an amount directly tied to your actual closing costs.

No matter which route you take, the trade-off with no-closing-cost mortgages is that you save money up front but end up paying much more over time. In a way, what you’re really doing is financing the closing costs just as you financed the home.

Keep in mind that not all lenders will necessarily cover the same costs and fees when they talk about covering “closing costs.” Be sure to talk to your lender about whether they cover lender and origination charges as well as third-party charges, such as title and settlement costs or attorney fees. Also be aware that prepaid costs at closing, like upfront mortgage insurance or homeowners insurance, may be treated differently.

Can I roll closing costs into my conventional mortgage?

It’s up to your lender whether it wants to offer a no-closing-cost mortgage option; there’s no rule that would prohibit conventional loans from being no-closing-cost loans. Assuming that the loan wouldn’t violate the guidelines set by Fannie Mae and Freddie Mac, a no-closing-cost loan could in theory also still be a conforming loan. If the loan violated the rules for a qualified mortgage (QM) loan set under the Truth in Lending Act, it could still be conventional but may be a non-qualified mortgage.

Can I refinance my mortgage with no closing costs?

Yes, you can refinance a mortgage with no closing costs just the same way you can take out a no-closing-cost purchase loan. In fact, no-closing-cost refinances are becoming more common and may be a little easier to find than no-closing-cost purchase loans.

With a no-closing-cost refinance, if you choose to roll the closing costs into the loan, you’ll be increasing the loan balance, which in turn means that you’ll be using more of your equity. This is, however, the cheaper of the two methods you can use to achieve a no-closing-cost refinance, since taking a higher interest rate in exchange for having your lender cover closing costs will typically be the most expensive option.

How much are closing costs on a mortgage?

Mortgage closing costs, sometimes referred to as settlement costs, typically range from 2% to 6% of your loan amount. That may sound minor, but it means that on a $470,000 loan, which is about the current median home price in the U.S., you’d likely pay between $9,400 and $28,200 in closing costs and fees.

Closing costs can be a much heavier weight to carry for low-income or first-time homebuyers, of whom more than 14% are facing closing costs that equal or even exceed their down payment amount. This is because closing costs are “regressive,” an economic term meaning they are higher as a proportion of the home price for low-income buyers than they are for higher-income buyers.

Summary of typical closing costs

Type of closing costsCan include charges like:Mean cost (among U.S. homebuyers)Typical (mean) percentage of home price
Lender and origination chargesAppraisal fee, application fee, credit report fee, processing fee, automated underwriting fee, document preparation fee$2,4060.90%
Title and settlement chargesSettlement fee, title endorsement fee, title closing fee, title examination fee, wire transfer fee$1,9610.70%
Other chargesHome warranty fee, attorney fees, pest inspection fee, HOA dues$3420.12%

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

When is a no-closing-cost mortgage a good idea?

  • If you’re planning to move or refinance before your break-even point, it can make financial sense to choose a no-closing-cost mortgage. The reason is that you may be able to exit the loan before you pay out more in interest than you saved by not paying closing costs.

For example, let’s say that you take out a no-closing-cost mortgage for a $400,000 house and roll in $12,000 worth of closing costs in exchange for a 0.5% increase in your interest rate. The higher interest rate bumps up your monthly payment by $200, meaning that you’ll reach your break-even point after 60 months or five years.

However, even if it looks like the basic math is working in your favor, you’ll need to be on the lookout for prepayment penalties that can add yet another line item to your total costs (if you refinance before a date set by your lender). Make sure you scour your loan terms or ask your lender directly about these fees.

  • If your No. 1 goal is to get into a house, and you can afford the payments but don’t have enough cash on hand to cover closing costs, then this type of mortgage could make sense. In some situations, having the security and stability of a place to call home is worth paying extra for. However, it’s important to know how much extra you’re willing to pay and to go in with a plan.

Pros and cons of no-closing-cost mortgages

Pros

  You save cash up front. If you don’t have a lot of savings, a no-closing-cost mortgage can help you close on a home without stretching your cash too thin.

  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 (PMI) since it’s usually required if you make less than a 20% down payment.

  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 with a refinance is when the amount you save in monthly payments 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 and higher total interest costs.

  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 will result in a higher monthly payment, so make sure your monthly budget can accommodate the payments before you commit.

  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 could increase your costs if you want to refinance to a lower interest rate down the line.

How to get a low- or no-closing-cost mortgage

Who offers no-closing-cost mortgage loans?

Any lender that offers mortgage loans can elect to offer no-closing-cost mortgages. Large, well-respected lenders like Rocket Mortgage, Bank of America and U.S. Bank offer them. Others, like TD Bank, have lender credit programs that may allow you to purchase a home and have some or all of the closing costs covered.

4 ways to reduce your closing costs

A no-closing-cost mortgage or lender credit 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 lender application and origination fees. Explain your needs to your lender and ask if it can reduce or remove fees. You may be able to lower your upfront costs without adding to your interest rate.

  Look for lenders that advertise low- or no-fee loans. “No fee” in this context only refers to lender fees, which means that you’ll still face third-party fees like appraisal, title and attorney fees. Still, finding a lender willing to eliminate its fees can be a way to reduce the amount of cash you’ll need to bring to the closing table. Just be cognizant of the fact that the lender will likely recoup these costs by making some other part of the loan more expensive.

  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 home seller and ask them to cover some of the costs. Closing costs that the seller agrees to cover are known as “seller concessions,” and they can be negotiated as you head toward closing.

 

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