Home >

What is a no-cost loan?

Closing costs are broken into two major categories, recurring and non-recurring. Recurring closing costs in a refinance are items that you would have paid even if you weren’t refinancing: mortgage interest, property taxes, and homeowner’s insurance. Non-recurring closing costs include all broker and lender fees including points, the appraisal, and title and escrow fees.

In a no-cost loan, the lender pays most or all of the non-recurring closing costs. You pay no points or loan fees, no appraisal or credit report fee, and, usually, no title or escrow fees. However, these loans always have a higher interest rate, if fixed, or some combination of a higher start rate, margin, or life cap, if adjustable, than a loan in which you pay the closing costs.

Consider a no-cost loan if:

• You either cannot or do not want to spend the money to pay closing costs. You may need the maximum amount of cash that you can take out in a refinance, or, if you are purchasing a home, you may want to keep your cash for moving expenses or remodeling.
• You are only going to be in the property for three years or less, not long enough to recoup your closing costs in the form of a lower payment. Remember, paying closing costs = lower rate = lower payment. If you pay closing costs of $3500, and you save $100 a month by paying them, it may make sense to pay them if you are going to keep that loan for 35 months or longer and if you won’t have another refinance opportunity.
• You believe interest rates will drop and you will be able to refinance again within two or three years at a lower interest rate.

Avoid a no-cost loan if

• You have the money to pay closing costs and want the lower rate.
• You are fairly certain that you will keep your mortgage for more than three years, and don’t believe you will have a refinance opportunity.
• You believe that interest rates are going to rise.

If you are considering a no-cost loan, always compare it to a similar loan where the closing costs are not paid by the lender. Try to compare the no-cost loan with a similar loan that has no points—but you pay the closing costs—and one that has a one-point fee. How much are the closing costs the lender is paying? How much more are you paying for the no-cost loan in the higher interest rate and monthly payment on a hybrid or fixed-rate loan, or in the higher start rate, margin, or life cap on an adjustable?