One of the biggest hurdles to homeownership for many would-be buyers is not necessarily the ability to get a mortgage loan, but the upfront costs associated with buying property. This includes the many costs buyers assume in the closing process.
Lenders may offer a no-closing-cost mortgage loan aimed at helping buyers avoid paying these costs upfront. But are these loans a good deal for the buyer? Let’s consider what’s really involved in a no-closing-cost mortgage and who really pays.
[Read: What Are Closing Costs?]
What Is a No-Closing-Cost Mortgage?
No-closing-cost mortgages and refinance loans allow buyers to minimize the upfront costs associated with closing on their mortgage. Sometimes this involves a lender actually waiving or covering some of these costs. But in many cases, these costs are just added to the total loan amount or reflected in a higher interest rate.
In these cases, the term “no-closing-cost” can be a bit deceptive, says Steve Hill, lead mortgage broker with SBC Lending. “In my eyes, there is no such thing as a no-closing-cost mortgage,” Hill says, “even if lenders market them that way.”
Closing costs include a range of fees, from loan origination, underwriting and processing fees charged by the lender to appraisal and inspection fees, attorney fees, title-related costs and government fees incurred in the process. In all, these costs tend to amount to about 2% to 5% of the loan amount.
Saving that much money upfront in the homebuying process can be helpful for some buyers, but it’s important to consider the long-term costs you may incur to do so.
[Read: Best Mortgage Lenders]
How Does a No-Closing-Cost Mortgage Work?
Keep in mind that just because a mortgage is marketed as having no closing costs, those costs still exist and need to be paid. While some costs involved with the closing process may be within the lender’s control to waive, many are charged by outside companies. If a lender is offering to cover those costs for you in some way, odds are the lender is making it worth the lender’s while, Hill says.
“There are fixed costs that have to be paid one way or another,” Hill says. “Escrow services and title insurance, for example — those companies have to get paid.”
A lender may market a loan as having no upfront closing costs, but this typically means those costs are being added to the loan amount. This means you’re not only still paying those costs, but also paying interest on them. “You’re not escaping costs,” says Scott Waters, a Virginia-based real estate agent. “You’re postponing them for a fee.”
Another common scenario involves lenders offering a credit to help cover your closing costs. But these offers typically come with a higher interest rate than you’d pay if you didn’t get a lender credit. For instance, Hill says, a lender may offer a qualified homebuyer a 5.5% interest rate on a $500,000 mortgage with the buyer paying all the typical costs. Or the buyer may be offered $5,000 lender credit toward closing costs, with a mortgage interest rate of 5.99%.
It looks like a small difference, and saving $5,000 in upfront out-of-pocket costs could make buying a home more accessible to a lot of prospective buyers. But it’s important not to overlook just how much costlier the higher interest rate is over the long term, Hill says. In this example, the higher interest rate would add about $156 to your monthly mortgage payment.
Over the course of a 30-year loan term, that amounts to more than $56,000 in additional interest that you’ll have paid to save $5,000 upfront. “The best way to save money in the long run is with a lower interest rate,” Hill says, “and no-closing-cost mortgages move in the opposite direction — higher rates.”
Pros and Cons of No-Closing-Cost Mortgages
Think of a no-closing-cost mortgage as more of a trade-off than a deal. As with any trade-off, there are pros and cons to taking one of these offers.
Pros
— Minimizes upfront costs. Closing costs can make taking out a mortgage prohibitive for many would-be homebuyers. The ability to avoid having to pay these out-of-pocket costs upfront could make buying a home accessible to these borrowers.
— Expands your loan options. Homebuyers who need low out-of-pocket costs may not always qualify for government-backed mortgage options that minimize upfront costs, like no- or low-down-payment Veterans Affairs and Federal Housing Administration loans. A no-closing-cost option could put a conventional mortgage within reach for these homebuyers.
— Frees up cash for other needs. The money you save on closing costs upfront could be used for other things. “A no-closing-cost mortgage helps free up money for other needs, such as home improvement or an emergency fund,” says Waters. You could also use that money to make a bigger down payment.
— Can be advantageous for short-term buyers. If you don’t plan on living in the home or keeping that particular mortgage for more than five years, you could avoid the long-term costs of a no-closing-cost mortgage. But selling a home and refinancing a mortgage come with their own separate costs that you should consider.
Cons
— Higher long-term costs. Whether the closing costs are added to the loan amount or waived in place of a higher interest rate, you will pay more over the long term than you avoid upfront — substantially more with the latter option.
— Higher monthly payment. If you increase your total loan amount or accept a higher interest rate to avoid closing costs upfront, you will also incur a higher monthly payment.
— Slower equity building. With a higher loan amount or interest rate, the pace at which your payments build equity in the home will be slower than if you had paid closing costs upfront.
— Alternative options may cost less. If you want to save money on closing costs, there are many programs available through the federal government, state and local agencies, and nonprofit organizations that offer assistance with closing costs. These programs may actually help cover closing costs rather than add them to your loan, which will save you money.
Where Can You Get a No-Closing-Cost Mortgage?
Any lender or broker may offer a no-closing-cost loan, but the specifics of each offer may vary. For example, some lenders may only waive their own fees but still leave you on the hook for other closing costs.
Make sure you know how all of the required closing costs are being paid for — particularly those that are paid to third parties like appraisals, title insurance and government taxes. Is the lender offering to cover those expenses for you, or are they being rolled into your loan amount? Is the lender providing a credit to cover those costs in exchange for a higher interest rate?
Loans that are marketed as having no closing costs can be especially prevalent in mortgage refinancing, Hill says. “Refinance-heavy shops will lean into the ‘no-closing-cost’ marketing to try and get homeowners to believe they got a better deal,” Hill says.
However, the same practices apply with refinance loans, and, in many cases, you are still paying those costs in the long run.
When Is It a Good Idea to Get a No-Closing-Cost Mortgage?
If saving money in the long term is important to you, a no-closing-cost mortgage may not be a good option. However, homebuyers who need to keep low upfront costs or those who only plan to keep the home for a short period could benefit from a no-closing-cost loan.
“It is a good way of keeping cash flow for buyers who are waiting for their new job transfer or for those who want to sell their property quickly,” says Waters. “However, if you are planning to invest in a property and stay there for a long time … in the long run, it is cheaper to pay closing costs upfront, as this helps one secure a better rate.”
More from U.S. News
How to Get Down Payment Assistance for a Mortgage
How to Read a Closing Disclosure
Everything You Need to Know About No-Closing-Cost Mortgages originally appeared on usnews.com
Update 09/26/24: This story was previously published at an earlier date and has been updated with new information.
