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There Is No Such Thing as a "No-Closing-Cost" Mortgage Loan.

You've seen the ads, and you probably wonder how some lenders can offer a no-closing-cost loan when others can't. The fact is that there isn't any such animal. And there are two ways in which consumers can be misled if they're not careful.

One way is that when the lender offers a no-closing-cost loan, it is talking about only its own charges, not anyone else's. A lender may offer a loan program that has no fees, but the fees that the lender is talking about may be processing or underwriting or other junk lender charges.

When you see a lender ad claiming "no closing costs," there might be an asterisk somewhere stating, "No lender fees; other fees will apply." Or the advertisement might say, "No lender fees!" While this is certainly closer to the truth, you also need to be aware that lenders can offset waiving certain junk fees by increasing the interest rate.

But a real no-cost loan means that you pay no money for anything: no appraisal fees, title insurance, attorney—whatever it is, you don't pay for it. At least, not outright. Here is a list of common nonlender charges:

Title insurance $ 500

Attorney $ 300

Survey $ 400

Documents $ 200

Settlement $ 500

Total $1,900

Somebody is going to have to pay these folks. They have to pay their bills, too, don't they? Well, if you're not going to pay them with a no-closing-cost loan, then who pays them? The lender will have to. But the lender can't really afford to do that—at least, not for very long if it keeps giving loans away and paying all its clients' closing costs.

Instead, the lender will offer to pay these charges in exchange for a higher interest rate. Here's how it works.

First, add up your closing costs; in this case, let's say $1,900. Now divide that figure by the loan amount you're getting from your lender. Let's say you're borrowing $250,000. So $1,900 divided by $250,000 = 0.008, or 0.8 percent. That represents nearly 1 discount point, and while 1 discount point will drop your interest rate by 1/4 percent, raising your interest rate by 1/4 percent means that you get nearly 1 "point" coming back to you, in this case, 0.08 percent of $250,000, or $1,900.

You agree to pay a higher interest rate in exchange for not paying any closing costs. Is this a no-closing-cost loan? Of course not. It's a higher cost that you pay each month in the form of a higher payment.

There is no free lunch when it comes to closing costs. You pay them in one way or another.

 
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