NO CLOSING COSTS?..."No Joke!"

Keep in mind the concept of discount points.  By paying points, you can buy the rate down.  Well, the reverse is true.  If you decide on a loan with a rate higher than the base rate, we as the lender are paid the opposite of discount points - called Yield Spread Premium.  We can use these funds to pay some or all of your closing costs.  No one works for free, the slightly higher rate gives us the funds to pay the attorney, underwriter, title insurance and so on.

Instead of paying for all the closing costs, with a rate between the full closing cost and no closing cost loan we can often do a reduced closing cost loan. 
 
This type of loan is not well known. With a no closing cost loan program, the borrower does not pay the costs typically associated with a loan closing such as lender's title insurance, survey, attorney's fees, appraisal, credit report, document preparation and underwriting fees. The borrower does not pay any points either. In addition, the borrower pays no application fee and no rate-lock fee.  You are provided with a full "HUD 1" settlement statement showing a lender credit for all normal closing costs. There is no catch, other than a slightly higher rate for these particular loans which generates a rebate for the lenders to use to pay the closing costs.

No closing cost loans can be used for either a refinance or a purchase transaction, although they are most commonly associated with a refinance. A no closing cost refinance is the quickest way to generate immediate interest rate and payment savings with no upfront investment in closing costs. To continue with our example, let's assume that a borrower is currently at 7.5% on a 30 year fixed rate loan and is interested in refinancing now that interest rates are declining. But what is the best time to finally ``bite the bullet'' and lock in a rate? If the person chooses to refinance using the no closing cost method, it doesn't matter when they lock in, so long as they are immediately saving money by refinancing. By choosing the 7.25% no closing cost loan, their payment would decrease right away, with no upfront investment to refinance. Should interest rates continue to decline, the borrower can simply refinance again to obtain additional savings.

The borrower is only responsible for 3 items.

• Pre-paid interest - This is interest from the date-of-record of the loan until the end of the month. This interest charge takes the place of the first month's mortgage payment. For example, if your loan goes to record on March 20, you would be charged for 11 days worth of pre-paid interest and your first mortgage payment would be May 1. The purpose of pre-paid interest is to bring you up to speed with the bank's monthly cycle of collecting payments on the first of each month. Pre-paid interest can be rolled into the loan amount if the client wishes. 
   

• Escrows - The client is responsible for funding an escrow account with the new lender for the purpose of having the lender pay the property tax and homeowner's insurance bills. The amount escrowed depends on what part of the payment cycle you close in...it can be as few as 2 months or as many as 11 months. In the case of a refinance, you will receive a check for a similar amount from your old bank after closing for the balance of your escrow account with them. Escrows are mandatory of your LTV is greater than 80% but can be waived (for a small fee) if your LTV is less than 80%. The fee to waive escrows is typically 1/4 of 1% of the loan amount and goes to the lender, not to us. Escrows can be rolled into the loan amount if the client wishes.
   

• Appraisal - We ask that our clients pay the appraisal fee directly to the appraiser when it takes place. This amount is then credited back to you at the closing table. 

2.  What is the catch?

There is no catch, but there is a cost. A No Point - No Closing Cost loan is typically priced at least .25% over a No Point loan (customer pays their own closing costs), and .5% over the typical loan that includes closing costs and a 1% origination fee.. A 30 Year Fixed Rate loan typically breaks down as follows...

As you can see from this example, although the No Point-No Cost program has a higher monthly payment, it has no cost associated with it. This means that you start saving money on your monthly payment right away.

If you choose the No Point-Reduced Cost loan, you would spend $1750 in closing costs to save only $33 per month. In other words, it will take you 53 months to break even....that is almost 4.5 years before you start saving money!

If you choose the loan with 2 points, you would spend $5,750 in points and fees to save only $98 per month. That is a 59 month break-even period...5 years!!!

The most important reason not to spend money for closing costs is flexibility. If you go with a No-No program and rates drop, you can refinance into another No-No program and start saving money immediately with no cost. 

Are you willing to bet $1750 - $5750 of your money that rates will not go any lower in the next 5 years? With a No-No program, you take all the guesswork out of trying to time the low point of the market...if rates drop, simply refinance to the lower rate at no cost.
  
When do no-closing costs loans work?

• The buyers are planning on staying in this home for just a few years
   
• The homeowner is refinancing, and the addition of closing costs into the new loan amount would put the loan over 80% loan-to-value (thereby triggering the need for monthly mortgage insurance)—or put the loan over the maximum allowable loan for a conforming program.

However, if the borrower is planning on staying in the home for many years and does have funds available for typical closing costs, going with the lower interest rate on a standard mortgage can mean considerable savings over the loan term. The key is to run the actual numbers for your specific case, and consider all options.

With a true no closing cost loan, you can refinance for any incremental drop in your interest rate. Because there is absolutely no investment in upfront costs, the savings of refinancing are immediate. In a market where you believe rates may continue to fall, it makes sense to refinance at no cost. Should interest rates decline further, you can refinance again without having to recoup the closing costs. Some borrowers refinance every few years at no cost, while keeping their initial teaser rate in an Adjustable Rate Mortgage like a 3/1 ARM.