Have you come across a no closing cost loan and figured it was too good to be true? It certainly sounds that way, doesn’t it?
Well it is a real loan. Just like any loan, there are good and bad sides to this financing option. Just like a store wouldn’t give away free products, your mortgage lender can’t give away free loans. They, just like the stores, have to make money. So how does this no closing cost business work?
Are There Really No Closing Costs?
First, let’s set something straight. You will have to pay some closing costs even on the so-called no closing cost loans. What this name means is there aren’t any lender closing costs. You won’t pay things like underwriting, processing, or document fees. You may, however, pay third-party fees. You’ll likely see fees, such as title fees, credit report fees, and attorney fees. There’s nothing the lender can do about the fees these essential services provide.
The no closing cost name stems from the fact that the lender won’t charge you any fees on the loan. Don’t get us wrong, this could save you money, but there are still fees you’ll have to pay at the closing.
How Does the Lender Make Money?
So if the lender doesn’t charge any fees, how do they make money? This is where the ‘catch 22’ comes into play. In exchange for not charging you any closing costs, the lender will increase your interest rate. If you were going to get a 4% rate on your loan, you might get a 4.5% rate if you opt for the no closing cost option.
Lenders look at closing costs as prepaid interest. It’s money they make upfront on your loan rather than waiting each month for your payment. If the lender eliminates these fees, they have to make up for the compensation elsewhere, which is why they charge a higher interest rate. This means you’ll pay a higher monthly payment for the term of the loan.
Does a No Closing Cost Loan Make Sense?
Here’s the bigger question. Does it really make sense to take out a no closing cost loan? In other words, what’s better – paying a large sum of money now or paying it slowly with each mortgage payment? The answer is that it depends on your situation.
First, ask yourself how long you plan to stay in the home. Is this your forever home? If so, it might make sense to pay the lump sum for closing costs now. This way you can secure the lower interest rate for the term of the loan. You will likely save a lot more money with the lower interest rate over the term of the loan by paying the closing costs upfront.
If you know this home is a temporary purchase, you may want to skip paying the lump sum now and take the higher interest rate. Let’s say you are going to live in the home for five years. That’s only 60 months of slightly higher payments. If you pay $50 more per month with the higher rate, that’s $3,000. If the closing costs would be more than $3,000, it makes sense to take the no closing cost loan instead.
If you fall somewhere in between these two scenarios, you’ll have to decide for yourself what makes more sense. Do you see yourself refinancing in the near future? If so, you may want to avoid paying the closing costs now and paying the slightly higher interest for the time being. If you aren’t the type to refinance or you can secure an exceptionally low rate now, you may want to pay the closing costs and leave the loan alone for the term.
The no closing cost loan can be beneficial, but in certain situations. Consider your situation carefully before you decide which way to go. This way you can make the most of your loan and hopefully get the largest return on your investment.