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Home Mortgages: Does a No-closing-cost Loan Make Sense for You?

I have heard a number of radio ads and have seen many newspaper ads offering "no closing cost" home mortgages. These ads will tell you that you can get a new mortgage or refinance your existing mortgage at absolutely with absolutely no closing costs.. There are no points, no charges for an appraisal, no charge for title insurance, no costs, period.

On the face of it, this sounds like a great deal and no-cost mortgages are especially popular with people who are refinancing an existing mortgage.

How does this work? Normally, a 30-year, fixed-rate mortgage, would have closing costs in the neighborhood of $2,000 to $3,000 or even more, depending on whether or not you pay points upfront. In fact, we talked to one mortgage broker two weeks ago about a mortgage on an investment property we own in another state and the closing costs were quoted as $7,000 - outrageous but at least not typical.

You've probably heard the old adage, "there is no such thing as a free lunch," and these no-cost mortgages are yet another testimonial to the truth of this.

The way that no closing cost mortgages work is the lender gives the mortgage broker a rebate at closing which the broker then uses to to pay the settlement costs. The way the lender gets its money back is by charging a higher interest rate. For example, for a $230,000, 30-year fixed rate mortgage with no upfront fees, your interest rate would most likely be a least 0.35% higher that if you paid one point and the customary closing costs.

Here's an example of what this means. As of this writing, there were mortgages available at 5.250 %, plus one point. As you probably know, one point equals one percent of the mortgage so one point on a $150,000 mortgage would be $1,500.

The monthly payment fo this loan, excluding taxes and insurance is $826.00. The closing costs would be $1,500 plus the normal settlement costs of, say, $1,500,A for a total of $3,000.

Let's compare this with a no-cost mortgage. Assuming the interest rate is 0.35% higher as quoted earlier, the interest rate on a 30-year, fixed-rate mortgage would be 5.725%, yielding a monthly payment of $872.98 or about $46.00 per month vs. the loan where you would pay one point and the normal settlement costs.

Given a savings of $46.00 per month, it would take you about 65 months - or 5.5 years to make up for the $3,000 you paid in closing costs. This means that you need to determine how long you will stay in that house before deciding on a mortgage loan or a refi. If you intend to stay in that home and not refinance your mortgage for more than six years, it might make sense for you to pay the point and the normal settlement costs. On the other hand, if you believe you will sell that house or refinance it in less than five years, a no-cost mortgage might be better.

Just make sure you look at all the various alternatives and their long-term costs before you leap into a new mortgage.

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