We’ve all seen or heard the headlines “No points! No fees!” or “No closing costs!” used in advertising, so let’s put this very complex subject into the simplest possible terms.
The truth about “no closing cost” mortgages is that they don’t exist. Not really. All real estate transactions, whether a purchase or refinance, involve costs and fees that someone must pay.
If your lender is touting some kind of no-closing-cost or no-fee mortgage, it probably means that the lender is paying those costs herself — Then passing them along to you in the form of a higher interest rate.
Always ask one question
Like most things in life, if it sounds too good to be true, it probably is. So, if this topic comes up when discussing your mortgage options, be sure to get the whole truth by asking one simple question:
Can you please give me an estimate showing what the loan costs actually are, and what my interest rate would be if I choose to pay those costs myself?
With that said, let’s take a closer look at this type of mortgage structure …
What exactly are closing costs?
Closing costs are fees/charges paid at the closing of a real estate transaction. Some charges are paid to third parties such as appraisers, title companies or credit report providers, and some are paid to the lender or broker. Some costs are actually not fees, like prepaid interest or insurance premiums, but are still necessary to close the loan.
Typical closing costs can include any of the following fees/charges:
- Tax service fee
- Title insurance
- Appraisal fee
- Inspection fees (required for some government loans)
- Mortgage insurance premiums
- Flood certification fee
- Credit report fee
- Processing fee
- Application fee
- Underwriting fee
- Document prep fee
The mortgage lender might also add origination charges or a loan discount fee (“points”), which can further increase the closing costs.
So, what is a “no closing cost” mortgage?
Many lenders offer a “no closing cost” or “zero closing cost” mortgage. With these mortgages, the lender will waive many of the initial closing costs and fees, while charging a slightly higher interest rate over the duration of the loan.
Once you’re 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.
Purchasing? Why no closing costs doesn’t mean free closing costs.
If you’re purchasing a home, it can be difficult to come up with enough cash to cover all the initial costs of home buying. In these circumstances, a no (or low) closing cost mortgage can help with that hurdle.
You may decide to have the lender cover closing costs for you in exchange for a higher interest rate to get into the home, but remember that the upfront savings will cost you in the long run.
It’s important to consider not just the upfront charges, but the total cost of the mortgage over time and you may decide to take a different approach like asking a seller to pay your closing costs or having a family member gift you the money.
There are many options available to homebuyers and ultimately if you don’t have enough funds to pay the costs associated with your home loan you may want to re-think whether the purchase is really a good idea. If your financial situation is so sensitive to the upfront costs, maybe you can’t afford the home.
We can help
Mortgages are complicated. To make matters worse, there’s a lot of misinformation and just plain bad advice out there. If you’d like to speak with some smart folks who can clear away the jargon and explain your home loan options in simple terms, you’ve come to the right place.
Don’t get bamboozled by clever marketing
It’s important not to get fixated on marketing hype like “no closing costs.” Each lender’s definition of “no closing cost” is slightly different. So when shopping for a mortgage, be sure to find out exactly what charges the mortgage provider will be responsible for, and which ones you will have to pay.
After reviewing your credit, savings and income, a qualified mortgage broker should be able to work with you and your needs. That process should result in finding the type of mortgage that works for you, or suggesting you put on the brakes and come up with a savings plan.
Always read the fine print
Even if a mortgage is 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 as well.
Other potential pitfalls to be wary of are 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, it’s not uncommon for some lenders to advertise a “no closing cost” mortgage, only to reveal in the fine print that if the loan 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.
The bottom line
If you’re short on cash or equity, a no-closing-cost mortgage may help get you into a new home or refinance your current home. Just keep in mind that you’ll pay more over the term of the loan and, as with all loans, you’ll want to understand exactly what it will cost you in the short term and over the length of a 30-year loan term.