What is a no cost loan

Real Estate Agent with Real Estate One 6501304423

Is a no cost loan truly a no cost loan? And what is a no cost loan? Every loan has closing costs.  Usually every loan has

  • appraisal costs
  • bank processing or underwriting fees
  • title insurance
  • tile closing costs
  • county recording fees

These fees usually range from $1500 to $2200 on a Michigan mortgage.  But on a no cost loan what happens is the mortgage company or the loan officer pays those costs.  The mortgage company or loan officer pays for the appraisal cost, underwriting fees, title insurances costs, and recording fees.

How do they do that do you ask?  It's easy because the higher the rate a mortgage lender sells you the more they make.  So let's say you are getting a 5.25% 30 year loan with $2200 in closing costs.  The mortgage lender may make 1% of the loan amount at 5.25%.  But at 5.625% the mortgage lender may make 2%.  So if the loan officer can sell a 5.625% and make 2% on the loan.  Then on a $200,000 the loan officer would make $4000.  He could pay $2000 of that money to pay all the closing costs.

So why would you take a no cost loan and get a higher rate?  Where most no closing cost loans happen are in refinances with falling rates.  Let's say you have a 6 1/8% loan that you got last year.  It doesn't usually make sense to refinance unless it is a full percent drop. 

It doesn't usually make sense to refinance because of the closing costs if you don't have a 1% or more drop in the percentage rate.  But what happens if you could save $50, $60, or $70 a month and it wouldn't cost you a dime.

That's why consumers use no-cost loans.  It reduces their monthly mortgage payments without costing them a dime.  But one downside of no cost loans or any refinance is that you start the clock over.  You now have a new 30 year mortgage.

So the bottom line is the loan officer doesn't make more money on a no-cost loan, but it may make sense for you.  Figure the numbers out, compare a no-cost loan to a cost loan and decide which is better for you.  So you can usually get a better rate when you pay the closing costs than if you got a no-cost loan.

I hope this explanation helps

Russ Ravary your Metro Detroit real estate agent 

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Comments (3)

Stephen Kappre
KW Hometown - Mantua, NJ
Helping You Home

Some clients indeed can benefit greatly, especially those with higher loan balances. Which brings me to the other point - someone with a higher balance would benefit regarding a rate drop of less than 1% - certainly a rate decrease of .5% on a $900.000 mortgage can make a sizeable difference.

Sep 13, 2009 12:50 PM
Russ Ravary ~ Metro Detroit Realtor call (248) 310-6239
Real Estate One - Commerce, MI
Michigan homes for sale ~ yesmyrealtor@gmail.com

you are so right Steve.  Here in Michigan we very rarely deal with loan amount of that size.  Our home prices are lower than on the East Coast or the west Coast.  The average loan size back in 2003 was in the $200,000 range.  I would bet the range is now in the $125,000 range.

Sep 13, 2009 01:08 PM
Brian Griffis
Realty Choice - Springfield, MO

There are always costs involved.  If you look at the rates involved, no cost loans are higher than a regular loan.  They have to get paid some way.

Sep 16, 2009 12:52 PM