So is there really such a thing as a loan with NO closing costs? Can you really get a mortgage for nothing (and your chicks for free)?
You certainly can . . . $0 in fees, but certainly at a price. And, for a lot of people — depending on a few factors — it may actually be the best way to refinance your mortgage.
An example is probably the easiest way to demonstrate a few options. Let’s assume that you have a $194,000 mortgage on a house valued around $250,000. Suppose you currently have an adjustable rate mortgage that was fixed for 5 years (a 5/1 ARM) and now after 4 years, it is soon to adjust. Based on today’s 1 year LIBOR index (and guessing at a 2.25% margin), your rate would adjust up to 7.5%, so you are pretty sure you need refinance.
On a refinance, there are really three ways to pay for the closing costs associated with the new loan. (For the purpose of this post, I’m just talking about closing costs; how to pay for the prepaid expenses and escrow money for the new loan are usually just a matter of personal preference).
One — you could pay for the closing costs in cash at closing. Over the course of my ten years in the mortgage business, I have never had anyone pay for their closing costs this way. At times, people who consider themselves to be hard-core consumer-guru follower-types like to ponder this option, but mainly just for nobility’s sake.
Two — you could increase the loan amount to cover the closing costs. If you financed the closing costs into the mortgage balance, you would end up with a total loan amount of approximately $200,000. Here’s how: the payoff on the old mortgage would be approximately $195,000 (because mortgage interest is paid in arrears, you have to add one month’s interest to your current loan balance of $194,000); and then add the payoff amount to the amount needed to cover closing costs — approximately $4,600 on a $200,000 mortgage. So in total . . . $194,000 loan balance + one month’s interest + $4,600 in closing costs = $199,600. At an interest rate of 5.875% for a 30 year fixed rate loan, the principle and interest payment would be $1,180 per month.
Or, three — you could increase the interest rate on the mortgage in order to cover all of the closing costs. People in the mortgage business refer to this scenario as a ‘lender-paid closing cost’ option or that the closing costs are being ‘paid through premium-pricing’ (on the radio, the guy likes to make it sound like he invented this third option and that he’ll do a loan for you with $0 in costs partly out of the goodness of his heart and partly because everyone else in the world is a ‘racket and a rip-off’ — what a generous fella). Essentially, in this scenario, the borrower accepts a higher-than-market interest rate to cover the closing costs. This higher rate causes the investor to pay the mortgage broker enough money to cover all of the closing costs (or the entire $4,600). The good news is that if you cover your closing costs this way, your loan balance would be equal to your payoff amount only, or $195,000. To continue the example, in this scenario, the interest rate would need to be moved up to 6.625% (better than the soon to be adjusted to rate of 7.5%). And at that rate, the principle and interest payment would be $1,248 per month.
The difference between option two (with closing costs) and option three (no closing costs) is $4,600 in costs and $68 per month. So which is the better option?? Well . . . it depends on your plans for the future. If you do the straight-forward math, in order to break-even on the expense of the $4,600 in closing costs at a $68 per month difference in payment, you would need to keep the loan for 67 months (or 5.6 years).
So, if you are going to be in the house (or keep the loan) for more than 5.6 years, you would be better to increase the loan amount to finance the closing costs and take advantage of the lower rate (option two). If you are planning on being in the house (or keeping the loan) for less than 5.6 years, you would be better off taking the higher rate and the $0 in closing costs (option three). This math will vary based on the size of the loan and available interest rates and is generally only available (because of the way investors price loans) for fixed rate mortgages.
Another advantage of the ‘no cost’ option is that if interest rates move lower, you can refinance again (either with costs or without closing costs) without kicking yourself for having spent the extra $4,600 in closing costs. Of course, if rates go up, and you end up living in the house for more than 5.6 years, you’ll wish you had taken the lower rate, spent the extra $$ in closing costs and saved yourself the $68 per month . . . which by the way . . . over 10 years will cost you an additional $8,160 . . . and over 30 years will cost you an additional $24,480, ouch.
So, I guess you really can’t get your money for nothing . . . but, hey, the clicks (here on ‘the mortgage blog’) are free.