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Every home loan and refinance comes with closing costs, which can be a hurdle if you’re short on the cash needed to close the mortgage. Fortunately, many mortgage 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.
What is a no-closing-cost mortgage?
Instead of paying closing costs all at once when you close, you could opt for a no-closing-cost loan so you don’t have to pay for them upfront.
“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.”
How much are mortgage closing costs?
The amount you will be charged for closing costs varies based on your location, the price of your home and the amount of your loan, but typically ranges between 1 percent and 4 percent of the loan amount, according to Matthew Posey, a certified mortgage planning specialist with Axia Home Loans in Austin, Texas.
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.
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 might 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.
Who offers no-closing-cost mortgages?
Most mortgage lenders offer no-closing cost mortgages. As you compare lenders, make sure you understand all aspects of the loan offer, including closing costs and any no-closing-cost options. Before committing to a no-closing-cost arrangement, consider how long you plan to stay in the home and how much cash you have on hand that you’re wiling to part with upfront.
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, 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. This option allows you to cut down on your upfront costs, which could benefit you if you don’t plan to stay in your home long-term or you have limited savings.
If closing costs are a burden, a no-closing-cost mortgage isn’t your only option. You could try to negotiate your closing costs and ask the seller to pay for all or a portion of them. You should ask the lender if it can waive or discount any of their charges, as well. If you’re working with a mortgage broker, the broker might even be able to help you save on costs.
If you’re refinancing and can’t afford the closing costs upfront, you might be able to use your home’s equity to cover them, Posey says.
There are advantages and disadvantages to no-closing-cost home loans, and not everyone is a good candidate for this strategy. Ultimately, the right option comes down to your longer-term plans, and possibly whether you have enough savings to pay the costs upfront.
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