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Are No Closing Cost Mortgages A Scam?

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I’ve been hearing a lot of advertisements on the radio, in print, and on television where lenders are offering mortgages and refinances with no points and no closing costs, which normally run into thousands and thousands of dollars. So how can they do it? How can they originate the loan, pay their people, and still turn a profit? Well there are two ways they can make their money – collecting interest over the life of the loan or by selling it to another bank and pocketing a finders fee of sorts. Since I’m not in the banking industry, this is all based on things I’ve seen and not any sort of professional knowledge, so take it for what it’s worth.

Nickel just analyzed a refinancing offer where he could lower his interest rate and after some math recognized that he could save $12,500 on the total cost of his home, so these clock-reseting (referring to the 30 year clock) mortgages aren’t necessarily trying to screw you by getting you to pay more in the long run by offering a lower monthly payment (be sure to do the math because they might be), so what’s the rub? Well, what it comes down it is that right now Bank A is earning the interest money at, say, 6.5% for the next thirty years and Bank B would like to be earning that interest for the next thirty years even if it’s at only 6.25%. Over the life of a 30 year loan, Bank B, at 6.25%, still earns over $243k on a $200k mortgage and a large portion of that interest will be paid in the first few years – that makes $5 in closing costs seem petty doesn’t it? (mortgage calculator)

Now, the second reason they might do it has a little less in terms of quantitative proof since I’m not in the industry but I bet they are able to package loans together and sell them to larger banks based on the aggregate credit ratings and interest rates on the borrowers and loans. I bet they’re able to sell those loans for a pretty penny, more than enough to cover paying their people to originate the loan.

So, in short, no closing cost, no points mortgages are not necessarily scams as long as you’re dealing with reputable people. As always, in any industry, there will be some charlatans and scammers so be sure to do your due diligence.

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6 Responses to “Are No Closing Cost Mortgages A Scam?”

  1. Jon Morrow says:

    There are a couple of ways to do this. First, sometimes mortgage bankers (direct lenders) offer to forgo closing costs as an incentive, but in my experience, it’s relatively rare. What usually happens is they wrap the closing costs into the loan balance. You still pay it, but not out of pocket.

    Some mortgage brokers will also entice buyers by offering to pay their closing costs. Then they increase the interest rate to slightly above the lender’s minimum rate. The lender pays them a higher backend spread (commission), and they use the money for your closing costs.

    So, you almost always end up paying them. It’s just a matter of how.

    Jon

  2. dong says:

    Yeah, they get you one way or another. A lender will never a true no closing cost mortgage at the same rate as a closing cost mortgage. As Jon said, they just backend the closing cost into the interest rate.

    Having gone through refinances, it’s always unclear even when I work out the math if I’m up or down (short term) just because of all the partial interest payments depending on the closing date. All very confusing.

  3. pfodyssey says:

    I agree with Jon. In my experience, the “no-fee close” was always paired with about a quarter percent increase in your mortgage rate. However, I haven’t minded this as it has provided me with a lot of flexibility in terms of refinancing in a market where interest rates are going downward. For example, if I’m having to shell out $3000 each time I refinance, I will be a bit choosy in terms of how often I do this (it becomes a sunk cost).

    However, if I’m just rolling it into the rate, I can do it many more times because I’m not out any hard cash that can’t be retrieved (again, the sunk cost). Although I certainly am “paying” for it, it is more than offset by the amount I save the next time I refinance at a lower rate. I did this quite a bit as I rode down our mortgage from a starting rate of 8.25% down to 4.75% over about a 5 year period.

  4. Anonymous says:

    I agree Jon, I think ti would be impossible to find a loan with no points and no closing costs that did not add these to the balance of the loan or perhaps the loan has a slgiths higher interest rate. It would take just a tiny difference in the interest rate for the bank to earn WAY more than enough to make up up for the “free” clsoing costs.

    Nothing in life is realyy free….especially when you get a bank involved (I work for one).

  5. In my case (read about it here since Jim mentioned it but didn’t link it) they were recovering their costs based on negative points. So par (= no points) was 5.875% and they were offering 6.125% with no costs (not even third-party costs). So by accepting a higher rate, there are negative points (i.e., paid to borrower) that swallow up the closing costs. On top of that, the broker makes a commission for handling the deal.


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