July 22nd, 2020 6:56 AM by Jackie A. Graves, President
Every home loan and refinance comes with closing costs, which can be a hurdle if you’re short on the cash needed to close on the mortgage. Fortunately, many lenders offer a no-closing-cost mortgage option, when the expense is rolled into the loan balance or padded into your interest rate, instead of paid in a lump sum on closing day.
How much are mortgage closing costs?
Every homebuyer wants to know: How much money do you need to buy a house? The answer is likely more than you expect, because it’s easy to overlook closing costs.
“Closing costs typically range between 1 to 4 percent of your loan amount,” says Matthew Posey, a certified mortgage planning specialist with Axia Home Loans in Austin, Texas.
The amount you may be charged for closing costs will vary based on your location, the price of your home and the amount of your loan. Depending on the final percentage, if you were to borrow a $300,000 loan, for example, your closing costs could range from $3,000 to $12,000.
Virtually everyone has to pay for closing costs, which include charges for essential expenses like the home inspection, appraisal, title fees, deed or mortgage registration taxes, recording fees, and loan fees that cover things like filing, underwriting, processing and origination.
What is a no-closing-cost mortgage?
Instead of paying these costs all at once when you close, you could opt for a no-closing-cost home loan.
“A no-closing-cost mortgage is one in which you aren’t required to pay closing costs upfront. But you’ll still be responsible for these fees,” explains Chuck Meier, senior vice president and mortgage sales director for St. Paul, Minnesota-headquartered Sunrise Banks.
“The only difference is that, under a no-closing-cost mortgage, your lender will either add those fees onto your principal balance or charge you a higher interest rate on the loan to cover those closing costs,” Meier says.
How no-closing-cost mortgages work
Make no mistake: You can’t get around paying for closing costs (there are only a few exceptions), but you can avoid having to pay them all upfront on closing day with a no-closing-cost mortgage.
If the lender agrees, option A involves rolling those combined costs into your loan balance. Let’s assume you’re seeking to borrow $250,000, and your closing costs total $8,000. That means you’ll actually borrow $258,000.
If the lender permits it, option B involves paying a higher interest rate on your loan. Say you qualified for a 30-year mortgage at a fixed rate of 3.5 percent. The lender may offer to up your interest rate to 4 percent (50 basis points higher) to cover your closing costs.
“With either of these choices, you will not pay the closing costs out of your bank account. But you will still pay for these closing costs over the life of your loan,” Posey says.
The majority of lenders provide no-closing-cost mortgages, so if your preferred lender doesn’t, shop around to see your options elsewhere.
Pros and cons of a no-closing-cost mortgage
Carefully weigh the pluses and minuses of choosing a no-closing-cost mortgage.
“The pros include not having to pay those additional fees with liquid funds,” notes Daniel Hill, a CFP and president of Hill Wealth Strategies in Richmond, Virginia. “There’s also the convenience of having your closing costs divided among your mortgage payments over the life of your loan.”
Another plus: You won’t need to bring as much cash to closing.
On the downside, “you’ll probably be getting a less-attractive loan than you otherwise would if you were willing or able to pay for closing costs,” cautions Rajeh Saadeh, a Somerville, New Jersey-based real estate attorney. “You’ll likely pay more interest over your loan’s term, depending on how long you stick with that loan.”
Case in point: Using the previous scenario, if you borrow $250,000 over 30 years at a 3.5 percent interest rate and pay your $8,000 closing costs out of pocket on closing day, the total cost of your mortgage (not including closing costs) would be $404,309.
However, if you choose to roll your closing costs into your interest rate (going from 3.5 to 4 percent), your total loan costs over 30 years would be $429,853.
In other words, you will have paid $25,544 extra in interest — a lot more than the $8,000 closing cost lump sum. If you were to choose the higher interest rate option, you can use Bankrate’s mortgage calculator to estimate your total costs.
How to decide if a no-closing-cost mortgage is right for you
A no-closing-cost mortgage is generally best for those who don’t plan to stay in their home for long, and potentially those without access to cash.
“If you don’t plan to live in your house for more than five to seven years, and you want to lessen your upfront costs, a no-closing cost mortgage could be the way to go,” Meier says.
“If you have minimal liquid funds available but you have high income and low debts, you may be able to benefit from a no-cost financing option,” notes Posey.
However, it’s wise to explore other alternatives before committing to this strategy.
“If refinancing, it may be beneficial to use your home’s equity to cover your closing costs. This allows you to borrow against your home instead of liquid assets to cover costs,” Posey says.
If you’re purchasing a home, you can try to negotiate your closing costs and ask the seller to pay for all or a portion of them.
“As the potential buyer, you can offer a slightly higher price than the asking price,” says Hill. “This way, the seller feels as if they’re getting more out of the transaction, and while you’re paying a little more than the asking price, you can preserve your low interest rate and avoid paying more in interest over your loan’s term.”
You can request that your lender pay some or all of the closing cost fees, as well.
“Mortgage brokers may be able to sweeten your loan package by sacrificing some of their commission and paying some of the costs associated with the loan. Or they may require that you use their preferred vendors, like a title company they partner with,” says Saadeh.
There are advantages and disadvantages to pursuing no-closing-cost home loans, and not everyone is a good candidate for this strategy. Ultimately, choose a mortgage option that’s best for your circumstances after determining the short- and long-term costs.
“Look into mortgage choices that you’re comfortable with and can afford,” advises Meier. “It’s necessary to think ahead and make a decision that best suits your unique financial situation.”
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