Why the No Cost mortgage is a HIGHER cost mortgage

Mortgage and Lending with Choice Finance Corporation

No closing cost mortgages have long been an attractive option for homeowners. When done correctly, they can indeed be a very good deal. I receive regular inquiries about these loans and my advice in this market is always the same: If you are planning on owning your property longer than 3 years, than it is probably MORE beneficial for you to obtain a mortgage with reasonable cost, than a mortgage with no closing cost. In all likely hood, it would probably be beneficial to pay points and get the LOWEST rate possible. The only time I recommend no cost refinances is for a NO COST FHA streamline.

To understand this, we must first start with how exactly no closing cost mortgages work: The term no closing cost is actually a bit deceiving in itself. The closing cost are still present, they must be paid by someone. This is accomplished by the broker using monies paid by the lender for selling you a higher interest rate. Example: You are requesting a $300,000 loan and your closing cost are $3,000. Lender X would have to pay the broker at least $3,000 just to cover your closing cost. Clearly this will not work for the broker, since we do not work for free. I hold about .75%-1% in commission on every transaction (the average broker is over 1.5%) So to offer a no cost loan on this scenario, I would need a rate where the lender is paying 1.75% or more to make it work.  Based on today's rates, your interest rate would be 5.375%for NO COST under this scenario. Which is a pretty good deal. But, is it the best deal? Let's dig deeper.....

Today, if you wanted a NO POINT mortgage, but were still willing to pay your closing cost, your rate would be 4.875% on a 30 year fixed mortgage. Let's compare:

$300,000 loan P&I (Principle and Interest) payment:

4.875% = $1588

5.375% = $1680

The difference is $92/month. If closing cost are $3,000; you would recoup your cost in 32 months (3,000/92). Then you would enjoy a savings of $92/month for the next 26.5 years, which totals $30,176 . Clearly, if you are planning on owning your property longer than 32 months, this is a better loan for you. But what about paying points?

 As of today, 1 point would could get your rate down to 4.375%. How does this stack up vs. the no closing cost option?

P&I payments:

4.375%  = $1498

5.375% = $1680

You save $198 per month! Keep in mind that closing cost go up to $6,000 since you are now paying 1 point (every point is equal to 1% of your loan amount- in this scenario, it would be $3,000) . Your cost recovery time on this scenario is 30 months (6,000/198). Something else to consider, the lower your interest rate- the MORE principle you pay every month. At the 5.375% rate, you pay $336 in principle month #1 of your new mortgage. At the 4.375% rate, you reduce your principle by $404 month #1 of your new mortgage. If you factor that $68 difference into the benefit of buying down your interest rate- the total goes from $192/mo. to $260 per month. This would bring your cost recovery time down to 23 months. Which makes this, the BEST scenario.

One thing to keep in mind is that everyone's situation is different, that is why you need to work with a mortgage professional that will treat you as an individual and take the time to break the numbers down like I just did. Call me today and I will offer you 3 NO OBLIGATION good faith estimates. 1 with No cost, 1 with no points and 1 with points. I will review all 3 with you and give YOU the information needed to make the right decision for you and your family.

Please go to www.joshburley.net to monitor rates in the DC metro area. If you are looking to purchase a home, check out www.choicerealestate.net for local listings.

Josh Burley
Sr. Loan Officer
Choice Finance Corp.
301.881.8900 x125

Comments (2)

BJ Matson
The Choice Group - Olney, MD

Thanks for the thorough explanation.  The market for 'no cost' loans has changed substantially.

Apr 29, 2009 08:26 AM

What is the downpayment required for a no cost mortgage?

Dec 28, 2009 06:50 AM