Why A “No Cost Mortgage” Still Costs

“There’s no such thing as a free lunch.” Such words have never been more relevant to consumers being pitched to take out a no cost loan. No cost mortgage mortgages have been around since the mid-90s and offer consumers the ability to pay no closing fees. The general closing costs, you’d otherwise pay in procuring a loan are paid for by the lender at the close of escrow. These include any lender fees, appraisal fee, processing fees, title insurance fees, escrow fees and recording fees. The loan contains no fees at the close of escrow or financed in the loan. In fact, no cost mortgages are going to soon become another mandatory disclosure lenders are going to have to show consumers.

Just last week on CNN Money, Richard Cordray Director of the Consumer Financial Protection Bureau, had the following to words to offer on the upcoming new lender disclosures “Consumers have a hard time comparing loans when they are dealing with a bewildering array of points and fees. We want to provide consumers with clearer options and enable them to choose the loan that they believe is right for them.”

No cost loans do provide the consumer another choice unique in world of mortgage finance. On the other hand, the fees associated with procuring that loan need to be paid by someone, and the cost comes in the form of a……drum roll please …….a higher interest rate, you got it, the no-cost loan contains a higher rate of interest over term of the loan.

Guess who pays the extra interest?

Yep, you got it. THE CONSUMER does.

No cost mortgages are inherently costlier, than their “fee mortgage” counterparts.

The the fact of the matter is that no cost mortgages do cost more and consumers must understand these loans do contain an inflated interest rate.

How a no-cost loan works: the mortgage lender offers you a higher interest rate over the term of the loan in exchange for providing you a dollar credit to cover your closing costs at the close of escrow.

For example looking at a loan amount of $300,000. The closing costs are $2,600. The lender credit is $2,600.

The lender might offer you three distinct choices;

1. 30 year fixed-rate mortgage at 3.5% with one discount point (based on 1% of the loan amount) and you paying $2,600 closing costs

2. 30 year fixed-rate mortgage at3.75% with no points, with you paying the $2,600 closing costs

3. 30 year fixed rate mortgage at 4.25%, no cost to you

Comparing option 3 to option 2-here’s how the math breaks down:

The 30 year fixed-rate mortgage at3.75%  contains total interest paid over the life of the loan in the amount of $200,164.84, so the total cost of the mortgage (computed by adding the closing costs to the interest paid over the full term) is $202,764.84.

Vs.

The 30 year fixed rate no-cost option at 4.25% since the closing costs are paid with the inflated interest rate, we only look at the total interest over the full term of the loan, in this case that amount over 360 months comes to $231,295.08.

The total cost difference is $28,530.24, or on a monthly basis it’s an extra $80 per month to have the lender pay the closing costs for you.

So if the closing costs are $2600, you would actually break even in 32.5 months by paying the closing costs yourself and forgoing the no cost option.

What it boils down to, is how long you plan to keep the loan for.

Notice how we recommend how long you keep the loan for and not how long you keep the house for.

If you plan on keeping the loan for:

3 year or less – a no-cost loan make sense considering that you’re going to be paying off the loan anyway

5 to 7 years-a no-cost loan begins to look less attractive to its fee mortgage counterparts

10 years or longer-no-cost loans take a backseat to fee mortgages

Other circumstances where no cost loans can be beneficial:

If you are in the process of refinancing and qualifying for mortgage is tight, perhaps due to assets or loan to value. For example if you have to pay down your principal balance to refinance your mortgage loan, a no-cost loan might make sense considering your cash assets would be going to the principal balance to reduce the amount financed.

Shorter-term loans such as 5,7, 10 year arms might make sense for the right client type for no feee loans.

*Mortgage Tip: because mortgage rates change daily, the spread between a no points mortgage loan choice and a no cost loan choice, can be anywhere between .5-1% in interest rate. The larger the spread between the two loan choice options, the higher the total cost of the loan over time.

Another underlining theme on every consumer’s minds today, securing the lowest possible Sonoma County Mortgage Rate. In order to achieve that, a no-cost option wouldn’t be suitable. To get the best possible interest rate and subsequently lowest monthly mortgage payment, consider taking out a no points mortgage loan or loan containing discount points “so long as” the interest rate is favorable.

If you are seeking a Sonoma County Refinance or any other type of home loan, we can provide you with clarity on the loan choices available so you can decide the most suitable loan program for your needs. Begin today by getting a mortgage interest rate quote. Learn Why A “No Cost Mortgage” Still Costs.

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Please email me your question or scenario and I'll get back to the following business day. -Scott