What You Need To Know About No-Cost Mortgages
When home buyers seek loans from mortgage lenders, they often have to pay closing costs associated with the processing of that loan. These closing costs often range between 3 and 5 percent of the value of the loan – amounting to thousands of dollars even for modest mortgages. A no-cost mortgage is a mortgage that does not include any such up-front fees. Naturally, buyers feel attracted to anything with the words “no-cost” in it and it is nice to avoid paying large sums of money up-front in a mortgage – especially since that is the entire point of mortgages. However, it is important to remember that the “no-cost” option does have its costs and while it is advantageous in some ways, it is not advantageous in others.
When lenders issue mortgage loans, they make a profit in two ways: fees and interest rates. While no-cost mortgages dispense with fees, they still incorporate interest rates. When banks do away with up-front fees, they usually accommodate for this change with higher interest rates. This may sound like a fair trade-off, but for a 30-year mortgage, the amount of difference that a slightly higher interest rate can make can amount to several times the value of what the normal closing costs would be. In most cases, the interest rate difference results in the buyer paying off what would have been the closing costs over the course of four to six years. After that, the higher interest rate is pure profit for the lender.
When lenders work through mortgage brokers, mortgage brokers receive lump-sum payments for originating those loans. While borrowers usually do not pay these fees directly, whatever the lender has to pay the broker is usually reflected in what the lender charges the borrower. In the case of no-cost loans, however, brokers tend to earn lower fees because lenders are not willing to pay them as much up-front for originating a no-cost mortgage loan as they would for a typical mortgage loan. For this reason, while borrowers usually still end up paying more to the bank in the end, this difference is offset somewhat by lower broker fees.
Despite the “no-cost” moniker, there are usually other fees to pay when you buy a house, even when your lender dispenses with loan processing and origination fees. For instance, regardless of the arrangement that exists between you and your lender, you may still have to pay state and local taxes related to home ownership. You may also have to pay for homeowner's insurance, as well as any applicable escrow fees. (To learn more about the different fees you may pay when buying a house, see Important Closing Costs And Fees To Consider When Buying A House.)
Change In Principal
In most cases, lenders that advertise “no-cost” mortgages or mortgages with “zero fees” really do remove up-front fees from the equation. In some cases, though, lenders can be tricky. They might try to tack that $2,500 or $3,000 closing cost on top of the loan amount requiring you to pay it off in installments along with the rest of the loan. This is a very unscrupulous business practice, but it is legal and lenders sometimes expect to get away with it. To make sure this does not occur, pay close attention to the total loan amount when you sign the loan agreement.
Sometimes, though, lenders openly offer such arrangements without intending to trick the borrower. In such cases, they tend to refer to their mortgage loans as “no-cash” loans rather than “no-cost” loans.
Transparency And Comparability
Despite the fact that some lenders may try to tack on their fees anyway and despite the fact that third-party fees often exist, most no-cost mortgages are quite simple and transparent. The lender just offers you a certain interest rate to borrow money so that you can buy a house. This transparency allows you to shop around and find the best offer, comparing one no-cost loan to another. With typical mortgage loans, banks many offer below-market interest rates to attract business while tacking relatively high closing costs to those agreements and it may take a significant amount of prying to figure out each lender's closing costs.
Real Estate Investment
The trade-off between lower short-term fees and higher long-term fees is a particular concern when considering how buyers intend to look at their real estate investment. For a buyer who intends to purchase a house and sell it again within just a few years, it may be more advantageous to opt for a higher interest rate if it means saving several thousand dollars up-front.
Sometimes, first-time homeowners are only barely able to get into their respective homes. While they may be able to make the required monthly payments, they may not have an extra $3,000 lying around for up-front fees. For such people, no-cost mortgages can be advantageous because it meets their immediate needs. However, in many cases, new homeowners can save a lot in the long run by instead waiting a few more months to accrue the necessary amount to cover closing costs. Do your homework ahead of time and you’ll be able to make the best decision for your financial situation.