How Does A No Closing Cost Mortgage Really Work?

Interested in how you can avoid more upfront costs? In this post, we’re breaking down what you need to know about a no closing cost mortgage.

Whether you’ve found the perfect home in your price range and you’re ready to put down an offer, or you want to refinance the home you’re already in, dealing with closing costs can hit your bank account hard.

Every time a mortgage is started, fees are generated to cover the services involved. These are referred to as closing costs.

So if you thought the price of the home was the only thing you were going to be paying for, think again.

However, a no closing cost mortgage may be an option to avoid additional upfront fees.

After all, wouldn’t it be great if your lender could take care of some of the costs for you?

What Do Closing Costs Cover?

The fees for the mortgage are known as closing costs, and they can range anywhere from 2-5% of the price of your house.

But why do you have to pay these fees?

A lot goes into the paperwork for a home purchase, and this is what you’re paying for.

Your paperwork will outline each fee in detail, but some of the items you can expect to see include:

Application Fee: This is so the lender can check your credit score and sometimes the appraisal. It’s a good idea to ask what this covers because sometimes the appraisal is a separate fee.

Closing or Escrow Fee: This is for the title or escrow company, who manages the process as an independent party.

Courier Fee: In order to expedite your loan, documents are transported as fast as possible.

FHA Up-Front Mortgage Insurance Premium (UPMIP): If you have an FHA loan, be prepared to pay 1.75% of the loan amount in order to cover the UPMIP. However, you can choose to roll this into the loan amount (but be careful — this will increase your monthly payment for the life of your loan).

Flood Determinator Life of Loan Coverage: You’ll need to hire someone to determine if your property is in a flood zone. (If it is, you’ll need to carry flood insurance separately.)

Homeowners Association Transfer Fees: The seller is required to pay this fee, and it includes information showing that all dues are current as well as a copy of the bylaws and rules and regulations.

Origination Fee: This is the lender’s administrative costs.

Prepaid Interest: This is any interest that accrues between the start and close of your first mortgage payment.

Survey Fee: In some states, a survey company is required to verify property lines.

Title Search: A thorough search will be done in property records to ensure no one else has a claim on the property.

Underwriting Fee: This is the fee to research the approval of your loan.

Keep in mind these fees will vary from state to state, so ask your Realtor or lender for an estimate ahead of time.

What is a No Closing Cost Mortgage?

All of those fees can add up quickly, and it can seem like a lot of money to shell out at the same time you’re buying a house or refinancing your mortgage.

However, a no closing cost mortgage can offer relief and may be a good option.

In this type of mortgage, the lender pays all of the one-time fees that would occur during the length of the loan, and in return, you pay a slightly higher interest rate.

For example, the lender would pay the application, title and escrow fees, appraisal, credit report and lender’s fees, but you would be responsible for the interest, insurance and property taxes.

Some mortgage companies will give you two options: one with a standard mortgage rate plus closing costs, and a second with no closing costs and a slightly higher rate, and they let you choose which option you prefer.

Other times you have to request the no-cost choice.

Closing costs vary from state to state, but they are showing an upward trend: In 2014, they jumped 6% in one year, averaging $2,539 for a $200,000 loan.

Is it Right for Me?

If the closing cost fees are putting you over the edge of being able to afford your dream home, or you just can’t pass up a refinancing opportunity, a no closing cost mortgage may be the right choice for you.

The key to finding out what makes the most sense is in the math.

If you know how long you plan to stay in your house, you can weigh your options.

If you plan to live in your house for less than five years, you should consider a no-cost mortgage.

Although there is a higher interest rate associated with this type of mortgage, which means your payment will be slightly higher, it is still less overall than the cost of what you would pay upfront when you close.

This also applies when you are refinancing your home.

When to Pay the Closing Costs

As mentioned previously, it’s all about the math when it comes to closing costs.

If you plan on retiring on your home, a no closing cost mortgage may not be a good fit for you.

After a few years, you’ll break even on the closing costs you paid versus the interest added onto your loan.

Plus, this extra interest is there for the life of your loan, whereas paying the closing costs is a one-time fee.

Those few extra percentage points can add up to a lot of money over the life of a 30-year loan.

Doing The Math

Let’s say your lender offers you two choices on a $150,000 loan.

One has a rate of 3.75% with $3,500 in closing costs.

The other is a no closing cost mortgage at a rate of 4.25%.

If you choose to forgo the closing costs, you’ll be paying $43.24 more a month, which totals $15,567 extra over the life of your 30-year loan.

However, if you chose to pay the closing costs upfront, it would take you 6 years and 9 months to break even versus paying the 4.25% rate.

So the question comes down to interest rates, the cost of your house and, ultimately, how soon do you expect to move in the future?

You’ll need to do some math, but your mortgage lender can help you weigh these scenarios and will guide you to the best solution. They can also help you compare different options.

Choosing a Mortgage Program

Depending on what type of loan you secure, closing costs may be inevitable.

However, a no closing cost mortgage is still an option for loans other than the traditional.

Veterans and service members can take advantage of the no-cost option with a VA loan, which finances 100% of the home and is guaranteed by the Department of Veterans Affairs.

With this type of loan, a veteran can borrow as much as $424,100 without a down payment being required.

FHA loans are also eligible for no closing cost mortgages.

These loans are backed by the federal government and are popular with first-time homebuyers.

Some perks of these types of loans include:

• Easier to qualify (lower credit score requirements)
• Easier to refinance your loan
• Lower down payment (as low as 3.5% of the purchase price)
• Mortgage insurance required

What About Refinancing?

If you’re looking to refinance your home, a mortgage without closing costs is still possible.

With interest rates hovering around all-time lows, it’s a good idea to lock in the lowest rate possible right now.

However, many homeowners are scared off by the closing costs.

Again, this is where the math comes in.

Even when you refinance, a no closing cost mortgage works the same as a traditional mortgage.

But keep in mind, even though you are refinancing your house if you choose to forgo your closing costs, the slightly higher interest rate will stick with you through the life of your loan.

So if you refinance your mortgage, for the first few years you will be paying off the cost of the refinance.

That means if you’re planning on downsizing in the future, it may be best to stay at your current rate — depending on how much lower it is.

But if you’re looking to renovate your home, you may also choose a no closing cost refinance.

Although you may be paying a slightly higher interest rate over the life of your loan, this may still wind up being cheaper than a home equity loan — and it may be an easier process.

Finding the Right Lender

Choosing the right mortgage lender is an important step in becoming a homeowner or refinancing your home.

When you work with a local company, you can save money on your mortgage when compared to the bigger, corporate banks.

Additionally, when you’re looking for something personalized like a no closing cost mortgage, a local mortgage business is more responsive and will work to get the best possible rate for you and your family.

It also may be easier to qualify with a bank that is closer to home, because larger banks are required to weed through layers of protocol after being fined by government regulators.

If you’re looking for a hometown lender that’s in tune with your needs, click here to start the process for a mortgage approval today.