No-Closing-Cost Mortgage Loans

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Closing costs on your home purchase can present a problem for potential homebuyers. Saving money for a down payment alone on your home purchase can be difficult; the scrimping and hustling that it took to bring you to the point of purchasing your home was likely not an easy task. Now that you are ready to buy a home, the last thing standing in your way are the closing costs.

Closing costs are a mix of the taxes and fees typically required with a home purchase, including

  • Appraisal costs
  • Tax service provider fees
  • Title insurance
  • Taxes
  • Origination fees
  • Application fees
  • Banking charges

The average total amount of closing costs ranges between 2% and 5% of the purchase price of the home. Let’s say you are buying a home with a value of $200,000. The traditional down payment of 20% is $40,000. When you add on closing costs, you may need to save an additional $4,000 to $10,000 to make your home’s purchase.

With the additional closing costs, your home purchase may be temporarily out of reach until you can save up that extra cash. One option that eliminates these fees is a no-closing-cost mortgage.

What is a no-closing-cost mortgage?

As an alternative to paying closing costs, some lenders offer no-closing-cost mortgages. These are sometimes also referred to these as zero-closing-cost mortgages.

When you choose a no-closing-cost mortgage, the lender will generally cover all of the closing costs. In return for this, the lender will charge a higher interest rate over the course of the loan. Although you are avoiding the upfront hurdle of closing costs, once in your home, you will have to make a larger monthly payment over the course of the loan.

At first, it seems like a great idea. You do not have to defer your homebuying dreams in order to save up for the closing costs. However, you should think carefully before signing up for this loan option. In exchange for the lender handling the closing costs, it will add significant costs to your loan over its lifetime.

The closing costs associated with the home purchase do not just evaporate based on the goodwill of the lender. Instead, these costs are commonly rolled into the loan, according to David Hosterman, a manager at Citywide Home Loans in Colorado. So you’re not truly avoiding closing costs completely, just choosing to cover those costs over the course of the loan.

Is a no-closing-cost mortgage a good option for first-time homebuyers?

Adam Smith, president of the Colorado Real Estate Finance Group, recommended that first-time homebuyers consider many aspects of a no-closing-cost mortgage before signing up. Think about how long you plan to keep the mortgage and the entire cost of the mortgage if you choose to avoid closing costs.

The obvious benefit to homebuyers is that you will be able to avoid a costly closing. However, you will have to pay a higher interest rate over the course of the loan, which can lead to the entire mortgage costing thousands or even tens of thousands of dollars more than the closing costs you were able to save upfront.

It is tempting for many first-time homebuyers to consider no-closing-cost mortgages, but it is important to think carefully before choosing loan terms that will be significantly more expensive in the long run.

Comparing no-closing-cost mortgages to conventional mortgages

Sometimes it’s difficult to know whether or not a loan is a good idea until you do the math. Let’s take a closer look at the overall costs associated with a traditional mortgage compared to a no-closing-cost mortgage.

In this scenario, you need a loan of $250,000 and would like a 30-year fixed-rate mortgage.
Lender A is offering a conventional mortgage with a fixed interest rate of 4.5% and the associated closing costs are $3,000. Lender B is offering a no-closing-cost mortgage with a fixed interest rate of 5% and no associated closing costs.

For Lender A, the monthly payment amounts to $1,267. For Lender B, your monthly mortgage payment would be $1,342. That’s $75 more per month than with Lender A.

If you decide to take the no-closing-cost option with Lender B, you will be repaying the lender the $3,000 of closing costs that the lender paid upfront. However, your higher monthly payment doesn’t end when you’ve paid off the $3,000. You will continue paying that extra $75 per month for the term of the loan.

If you stay in the home and keep the same mortgage terms for the entire 30-year term, then you will pay the bank $24,000 more than with Lender A’s option. If you do not intend to stay in the home for the full 30 years, then you will only pay an extra $75 per month for the amount of time you hold the loan.

In the long run, a no-closing-cost mortgage can cost you tens of thousands of dollars.

Important things to consider

When you are shopping for mortgage options, be sure to read the fine print of each individual lender because each has a different definition of a no-closing-cost loan. Take a close look at the specific charges that will be covered by the lender and the fees you will still be responsible for.

Most no-closing-cost loans will not cover every tax, fee or insurance premium. Many times, homeowners insurance, private mortgage insurance, certain taxes and other recurring fees will not be covered by the lender.

One option you may consider is repaying your mortgage loan early in order to avoid the higher price tag for longer, but you need to be careful. Some no-closing-cost mortgages have prepayment penalties that could make it an even more expensive option.

Another option for a homebuyer that chooses a no-closing-cost loan with a high interest rate is refinancing. However, no one can predict the future lending climate, so you may end up stuck with a higher interest rate that you are unable to refinance.

Alternative lower cost mortgage loan options

Although no-closing-cost mortgages provide an attractive option to homebuyers, there are other low-cost mortgage options that you may want to consider.

VA home loans allow eligible veterans, servicemembers and surviving spouses to purchase a home with little to nothing down. Even with a low down payment, VA loans still offer competitive rates and are backed by the government.

FHA loans are another federally back option that require down payments as low as 3.5%.

USDA home loans are an option for homebuyers in rural areas. They also offer low down payment options.

If you believe you qualify for any of these homebuying programs, then consider these as an alternative to a no-closing-cost mortgage. They may help you to avoid a high interest rate over the lifetime of your loan.

The bottom line

Although a no-closing-cost mortgage can help a homebuyer with limited savings purchase a new home, it will require them to pay more over the course of the loan.

If you only plan to stay in your home for a few years, then you may not be too worried about the long-term price tag of this loan option. However, if you plan to stay in the home for decades, then it is important to understand that you will pay more over the lifetime of the mortgage unless you are able to refinance for a lower interest rate.

You may consider delaying your purchase until you have saved enough to cover the closing costs. If you are set on buying a home right now, then you may want to consider less expensive options or a federally guaranteed loan like the VA or FHA programs.

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