Is a No Cost Mortgage Really No Cost?

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HUD-1The last few years have been dismal for the housing market and because of that, you may not be in the market as a buyer or a seller but someday you will and that someday may be sooner than you think. You may get a promotion, a transfer, or a new job. You may find a great deal on the home of your dreams or it may simply be time for a change.

Even if you won’t be purchasing a home in the near future, you could avoid mistake later by preparing yourself now. Most people who have purchased a home go in to the mortgage lending market with little or no knowledge of how it functions. We follow the lead of our real estate agent and end up taking their advice on what is the best option for us. We don’t do this in other areas of our life so why do we do it for what will probably be the largest purchase we make?

Let’s change that today. Let’s start learning a little about the mortgage lending market so when the time comes, you’re armed with the knowledge you need to ask the right questions.

What is a no cost mortgage?

First, any time you’re evaluating options such as this, ask yourself the question, “why me?” In this case, why would a bank offer to pay all the fees associated with giving you a loan? Of course, they wouldn’t so those fees must be somewhere and in the case of a no cost mortgage, they’re added in to your interest rate. The lender totals the amount of fees that you would normally pay for the loan and adjusts the interest rate to cover those fees.

A no cost mortgage isn’t completely no-cost. The lender doesn’t pay in to your escrow account, doesn’t pay you homeowners insurance and can’t pay your per diem interest. This is the interest from the date of your closing to the first day of the following month. They can’t pay it because the exact closing date may change after the contract is generated.

Are they right for you?

No cost mortgages are a good idea for some people. For those who plan to stay in their home for a relatively short period of time, it may very well be a good idea. If the house is sold before the fees that are built in to the interest rate are paid, the no cost element of the loan is advantageous for the homeowner. The BEP or break even point is the point of time where the homeowner starts paying more interest on the fees than if they would have paid them upfront. The BEP is difficult to calculate before the loan is finalized but often, the BEP is between four and ten years from closing. If you plan to stay in your home for decades, pay the fees up front.

How to shop for a no cost mortgage

No cost mortgages are more customer friendly than traditional mortgages because shopping for one is easier. Since the lender can’t quote you an interest rate and then later add fees to make more money, they have to quote you their lowest interest rate to remain competitive. This also means that their estimate of the fees has to be as conservative as possible in order to keep the rate low. One study found that no cost mortgages had fee estimates $1,500 lower than traditional mortgages.

While you may be not in the market for a new home right now, take some time to learn about the mortgage lending market so you’re better equipped to get the best loan terms down the road when you’re a buyer. Buyers who go in to the mortgage market with little or no knowledge are at the mercy of the banks and that’s never a good idea.

(Photo: toddwickersty)

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4 Responses to “Is a No Cost Mortgage Really No Cost?”

  1. Steve says:

    If you aren’t 100% sure how long you will be in the house (I’ve heard that most people move sooner than they planned), perhaps taking a “no cost” mortgage is a good way to hedge your bets? With all the other transaction costs of buying and selling a house, you’re already betting pretty heavily on staying in the house a long time.

  2. Brianne says:

    We recently re-financed and actually ended up getting nearly $200 back, dropping our interest rate from 5.125% to 4.375%. Too bad that new rate seems awfully high now.

  3. David M says:

    I am completing my 3rd no cost mortagage next week in less than 3 years!

    My rates have been 5.25% for 15 years, 4% for 10 years and 3.5% for 10 years.

    As Brianne states my new mortgage rate now seems high – however next year if rates are still low I can refinance again why not – it costs me nothing!

  4. Joe says:

    I’ve been searching for a no-cost mortgage but haven’t been able to find lenders that offer this option. Any suggestions?

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