No-Closing-Cost Mortgage: Does It Make Sense For You?
Carey Chesney5-minute read
August 20, 2020
Buying a home is a big investment. For many people, coming up with the necessary funds to make it possible can be a big financial – and emotional – strain. Fortunately, there are ways to mitigate this burden and manage many of the costs of closing on your new home.
When you find the home you want, the checkbook comes out for a number of different expenses. First, you need to pay for an inspection to ensure there aren’t any big problems with the house before you fully commit to buying it. Next, you need to pay for an appraisal to ensure the house is worth what you’re offering for it. You don't want to overpay, of course, and your bank won't approve a loan for a house that’s not worth it. After all that, it’s time to get into closing costs. This can become really expensive, usually ranging anywhere from 3% – 6% of the price of the home. This means that if you take out a mortgage worth $100,000, you can expect closing costs to be about $3,000 – $6,000. These costs don't always need to be paid by you – the seller can be asked to cover some of it – but it’s still usually a pretty big chunk of change. Keep in mind that this doesn't even include your down payment, not to mention all the other collateral expenses of moving all your stuff and decking out your new home in your personal style.
So, what do you do to help with all of these costs? One option that can alleviate some of this upfront financial burden is a no-closing-cost mortgage. In this scenario, the lender will pay for many of the initial closing costs and fees and then make up for it by charging a higher interest rate over the duration of the loan. This is different from a no-closing-cost refinance, which deals with a current mortgage instead of a new one for the purchase of a new home.
What Is A No-Closing-Cost Mortgage?
Let’s dive a little deeper into the definition of a no-closing-cost mortgage. When you buy a home, there are a number of different costs and fees that go into what is broadly referred to as “closing costs.” These usually include (but are not limited to) home appraisal fees, title insurance, and property taxes. The amount can vary but depending on a variety of factors they can quickly become pretty substantial. Applying for a no-closing-cost mortgage helps with these fees, as the lender will commit to paying them up front and making their money up on the back end by charging a higher interest rate for the duration of the loan.
How Do No-Closing-Cost Mortgages Work?
To be clear, a no-closing-cost mortgage doesn’t mean you’ll never have to pay closing costs. As you may have guessed, lenders will figure out how to make sure you pay for everything eventually. In this case, the lender rolls the closing costs into larger monthly payments with interest for the duration of your loan. So, while you don't need to come up with as much money up front, the amount you pay over time will be comparable to a traditional mortgage, or more. In fact, it’s usually likely to be more because the increase in the amount of interest is often more than the initial savings you enjoyed by not paying closing costs up front. In addition, lenders may also add a prepayment penalty provision to the loan to discourage you from refinancing again before they’ve recouped their costs. Be sure to do the math to see what makes the most sense, but in most cases paying your closing costs up front if you can means paying less money overall. Rocket Mortgage® does not have prepayment penalties.
Pros And Cons Of No-Closing-Cost Mortgages
Like almost everything in life, there are both benefits and drawbacks to going with a no-closing-cost mortgage. Each person and situation calls for a variety of solutions when it comes to buying a home. What is a great approach for a first-time home buyer may be a huge mistake for someone looking to add a second home on the lake. The devil is in the details, and understanding the good, the bad and the ugly when it comes to no-closing-cost mortgages will help you make an informed decision. Let’s take a look at some of the pros and cons so you can make the best choice.
- Fewer upfront charges can help relieve the financial burden when you’re first purchasing a new home. A couple of the types of buyers that often benefit from this are first-time home buyers and short-term residents. First-time home buyers often have a little more trouble coming up with funds in the beginning of the process and people who are only planning on living in a home for a short amount of time won’t see the benefits of lower interest over the course of a traditional mortgage.
- Less payment up front means you will reach your “break even” point earlier.
- It could be more expensive in the long term (especially for those looking to live in their new home for a long time) due to elevated mortgage origination fees and higher interest over the course of the loan.
- Higher monthly payments compared to a loan where you pay closing costs up front.
Who Offers No-Closing-Cost Mortgages?
Lenders vary in almost every aspect of what they offer and who they will offer it to, and no-closing-cost mortgages are no different. They will take into account a number of factors when deciding whether to lend money to a borrower, including credit score, credit history, employment and much more. Look for transparency and service level when evaluating lenders and inquiring about no-closing-cost mortgages. For example, Rocket Mortgage® offers award-winning client service, which means you can expect clear communication from loan experts about every aspect of your home loan, including closing costs.
Is A No-Closing-Cost Mortgage Right For You?
If you're looking for a yes or no answer, sorry to disappoint. The truth is, no-closing-cost mortgages can make a ton of sense for some people and zero sense for others. As a general rule, you’re probably going to pay less over the entire life of a loan if you pay closing costs up front. That said, coming up with the necessary funds to do that isn’t always easy, so spreading out the cost of closing over the whole loan term might be the right choice for some. Bottom line, do as much research as you can and don’t stop asking questions to hold your lender accountable in terms of transparency and laying out every possible option for you. Don’t know where to start? Check out more mortgage basics articles in the Rocket Mortgage® Learning Center. When it comes to lending and real estate, knowledge is power – the power to find and buy your new home!
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