For most of us, sniffing out deals has become second nature. Our ears perk up at the mere mention of “free” or “no cost.” But when it comes to your mortgage, “no cost” is not the same as “free.”
No Cost vs. Traditional
In a traditional mortgage, the borrower pays certain fees, appropriately called closing costs, when the loan closes. Closing costs average $3,700 nationwide and include costs incurred by the lender to process the loan such as attorney fees, title company fees and document preparation fees. Since closing costs can equal 2–4% of the loan amount, an offer to skip these fees sounds like a good deal.
A quick note: No cost is not the same as no cash. In a no-cash closing, the costs are rolled into the loan balance, and the borrower pays interest on them over the life of the loan.But we know lenders don’t pay these fees out of the goodness of their hearts. Someone has to pay them, and it isn’t going to be the bank! What happens is the borrower ends up paying a higher interest rate in exchange for the no-cost closing. That means, over time, the borrower could end up paying more in interest than he would have by paying the closing costs up front.
Deal or No Deal?
So is a no-cost loan a good deal? Let’s do the math on a $200,000, 15-year mortgage. Over the life of the loan, you’ll pay $8,900 more with a no-cost loan at 4% interest than you would on a traditional mortgage at 3.5%. That’s an extra $50 a month. If your closing costs are $3,700, you would break even with the traditional option in about six years.
In this case, the no-cost option will not be to your advantage unless you pay off the mortgage in less than six years. If it will take longer to pay off your home, then pay your closing costs up front. The break-even point on your loan will be different, so always do the math first.