While searching for mortgage lenders, you may have come across the intriguing term “no closing cost mortgage”, also known as a “zero closing cost mortgage”. In this article, we’ll explain the meaning of a no closing cost mortgage and give you the tools to decide if it’s right for you. But before explaining the meaning of a no closing cost mortgage, we first have to understand the concept of closing costs.
Closing costs, also known as settlement costs, are all the fees you pay when you close on your house (excluding the down payment). These costs typically range from 2 to 6 percent of the loan amount, so that a loan of say $300,000 could incur closing costs of $6,000 to $18,000. Lenders are obligated by law to provide you with a full breakdown of your closing costs within three business days after you submit a mortgage application.
Closing costs may consist of lender and third-party fees such as:
- Origination. – This is a fee paid to the mortgage lender for the processing and underwriting of the loan. This fee varies between lenders.
- Appraisal fee. – An appraisal must be conducted by an independent third party to confirm the fair market value of your property. The typical cost of an appraisal for a single-family home ranges from $300 to $500.
- Survey or inspection fee. – Most lenders require a home inspection to ensure the home is structurally sound, particularly in the case of government-backed mortgages such as FHA loans and VA loans. Like appraisals, inspections generally range from $300 to $500.
- Title search and insurance. – Most lenders require a title search by a third party to ensure there are no ownership disputes or liens on your property. Title insurance protects the lender in the event of an ownership dispute or lien during your repayment term. These are typically up-front, one-time fees.
- Private mortgage insurance. – If your down payment is below 20% (which is generally the case with government-backed loans as well as low down payment conventional loans), your lender will probably require you to pay monthly mortgage insurance. Some lenders require the first year’s insurance premium up front while others have been known to ask for the entire amount in a lump-sum payment. This on its own can reach up to 2% of your home’s purchase price.
- Homeowners insurance. –Home insurance coverage is a requirement of all lenders. It is paid to a third-party insurance company in monthly installments, but your lender may require you to pay the first year up-front. The price of homeowners insurance depends greatly on the value of your home, but it usually ranges around $1,000 to $2,000 per year.
- Other third party fees. – The mortgage process often involves the participation of various third parties such as escrow agents and attorneys. These form part of your closing costs.
- FHA, VA, USDA loan fees. – Certain additional closing fees may apply in the case of these government-backed mortgages.
The term no closing cost mortgage is a little misleading. Obviously, no lender will ever free you from your closing costs. However they may agree for you to spread the closing costs over the duration of your repayment term instead of having to pay it now. Essentially, a no closing cost mortgage is a way of financing your mortgage costs. Instead of paying closing costs up front, you essentially borrow the amount and pay it off in monthly installments – with interest, of course.
Pros. – The benefit of a no closing cost mortgage is that it can spare you a ton of money in upfront fees. You already have a down payment to worry about, and you may not want to add on $5,000, $10,000 or even $20,000 in upfront fees. A no closing cost mortgage makes some or all those fees vanish – for now.
Cons. – The downside of a no closing cost mortgage is that it doesn’t actually save you from having to pay the fees; you’ll still have to pay them off, with added interest. The higher the closing fees and the longer your repayment term, the more you’ll end up paying to the lender in the long run for a no closing cost mortgage.
People often confuse closing costs and points, so it’s important to be aware of the differences.
Mortgage points, also known as “buying down the rate”, give you the option of paying an upfront fee to lower your interest rate and monthly payments. A typical formula is one mortgage point equals 0.25%, so that purchasing one point on a 3% mortgage would reduce the interest rate to 2.75% for the life of the loan, for example. Of course, the cost of a point varies between lenders, which is why it’s worth shopping around to see who has the cheapest mortgage points.
As you can see, mortgage points actually add to your closing costs. In contrast, a no closing cost mortgage reduces or eliminates closing costs. Therefore, it doesn’t make sense to use both. If you’re willing to accept a higher monthly payment to pay less in upfront fees, then you need a no closing cost mortgage. If you wish to pay more in upfront fees in order to lower your monthly payment, then you need mortgage points.
Mortgages involve lots of decisions that ultimately affect both your monthly payment and the total price of your loan. A no closing cost mortgage is a bonus option offered by lenders that empowers you to customize your mortgage to suit your borrowing ability. As with all aspects of your loan, assess the numbers for yourself to decide whether the benefits of a no closing cost mortgage outweigh the costs.