The No Closing Cost Loan Bait and Switch
Buying property is not cheap – and most want to spend a little more on improvements after they close – so it makes sense that buyers want to keep their own cash. No closing cost loans can help you reduce the amount it takes to buy a home, but they’re certainly not free loans and they are not paying your closing costs for you.
If you’re tempted to use a loan with no closing costs, you need to understand how they work, what the tradeoffs are, and when they make the most sense.
Borrowing IS NOT Free
Any time you borrow money, somebody gets paid. The lender earns interest which is easy enough to understand, but what about transaction costs? One-time charges for credit checks, appraisals, origination fees, and title searches need to be paid. Mortgage brokers earn a commission, and others might earn referral fees. Who pays for all those?
Of course, you do – you are the one “buying” the loan and paying all the costs to get the loan. That’s the bait – I’m going to give you a loan at “no cost!”
The switch – and what they don’t say….
No Closing Costs = “Higher Rate”
When you choose a no closing cost loan, YOU still pay the fees. Please know this: those loans have higher interest rates. Instead of you paying up front, you pay a little bit extra over time. The cost gets added – in slightly higher payments – to each monthly payment you make.
That’s not necessarily a good or bad thing. The question is how much extra you’ll pay month after month – and is that a better deal than paying all of the costs up front?
This is where you want to do the math for yourself and weigh out your personal benefit: pay no or pay a little over time which will add up to a much, much higher amount. To figure that out, you might need to do a little math, and you’ll need to make some assumptions about how long you’ll keep the loan.
A loan with a higher interest rate means you’ll have a higher monthly payment. If you’re curious about how that works, download my (link this text) monthly payment calculator and give it a whirl. Change the interest rate in the calculation and see how much it affects your payment. Compare the rates available for loans with and without closing costs.
For example, the difference might be 0.5% (get an actual quote from me based on your loan and credit score to be sure you’re working with real numbers).
On a $250,000 loan, the monthly principal and interest payment would be $1342.05 if you borrow at 5%. If you bump that up to 5.5% (because you’ll pay no closing costs), the payment would change to $1419.47. For how many months is it worth paying that extra $77.42 per month? It will depend on how much the closing costs are, and how badly you want to keep the cash in your pocket.
Sometimes No Closing Costs is a Good Idea
Paying extra each month is not necessarily bad. It is a choice and in some cases, the right one for you. You should base your decision on the right information – all of it, good and bad.
Loans with no closing costs can work out best when:
1. Rates are high and you expect them to go lower soon
2. You’ll only keep the loan for a few years
3. If rates will go down in the near future, it might not make sense to pay large expenses out of pocket to lock in a high-rate loan. You might try to just pay a little extra each month, and then refinance the loan if rates fall.
Unfortunately, you can never be certain about the amount or increase/decrease of interest rate changes. They actually change 3 times per day! You have to make some assumptions and even make an educated guess.
If you’re confident that you’ll sell the house or refinance the loan within a few years, maybe five years or less, then it might make sense to skip paying the closing costs for now. You’ll pay that higher monthly payment for just a few years – not the entire term of a 30-year mortgage. You might know that a job change is in your future, or issues in your credit report will allow you to get a much better loan in the future. Again, it’s impossible to predict the future, but you can always make plans with what you believe the future will bring.
Sometimes No Closing Costs is a Bad Idea
For almost all of us: It hurts to pay large costs right now…. but that might be the right thing to do if you can set yourself up nicely for the long term. And if you can really afford to pay the money now. This will ensure a smaller monthly payment for many years and help you spend less overall.
Let’s use the $250,000 loan as an example again:
The loan will cost you $5,000 in closing costs (just an example). So you pay the $5,000 now, finance $250,000 at 5% over 30 years. Your payment is $1,342. Your loan total cost is $483,139 for 30 years.
-OR- you roll the $5,000 closing costs into the loan (keep your cash) and finance $255,000 at 5% over 30 years. Your payment is $1,369, only $27 higher per month. Your loan total cost is $492,802 for 30 years, or $9,663 more.
There are three things to really consider: your overall balance: $250,000 versus $255,000 – which always means less equity. The payment difference: $27 more per month but $5,000 still in your bank account to be used however you like. AND lastly: the overall cost. Keep your $5,000 and pay $9,663 more overall.
Think twice about taking the higher rate in trade for no closing costs.
If you’re interested in no closing cost loans, be sure to consider all the factors and spend at least a little time running the numbers. Yes, it feels like homework, but it’s an important decision. Then, come talk to me. I can help.
I can even provide you with the different options – some of them with closing costs and others with different levels of closing costs. With all the options in front of you, you’ll see that you can find a level of cost that’s acceptable to you.
Closing costs are complex, and no closing cost loans are NEVER as cheap as they seem. Make sure you understand how closing costs work before financing, you’ll be happy you made the best choice for you.
This guest blog was written by Daniel White of Envoy Mortgage and Eureka Team Member
