You hear that you have the option to get a “no closing cost” loan. You immediately, think “Sign me up!” Who wouldn’t want to save thousands of dollars on their refinance? But, before you do, there are some considerations you must make. While the name makes it seem like the loan does not cost you, in reality, it does. We show you how below.
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HOW LENDERS OFFER A “NO CLOSING COST” LOAN
You might wonder how a lender could get away with not charging closing costs. Not only do they have to make a profit, but they have third parties they must pay. So what’s the catch?
Like you thought, lenders aren’t going to give you a loan for free. They have to make the money somewhere. In this case, it’s in the interest rate. Let’s say a lender qualifies you for a 4% interest rate on a 30-year loan. However, that loan will cost you $4,000 in closing fees.
Now, let’s say the lender offers to pay the closing costs for you and give you a 4.5% rate. Do you see where the difference lies? It still costs you because you’ll have a higher interest rate. Let’s look at the difference in the payment. For this example, we will use a $200,000 loan.
The 4% rate will give you a principal and interest payment of $955.
The 4.5% rate will give you a principal and interest payment of $1,013.
That doesn’t sound like a lot and it’s not. Per month, you’d pay $58 more. That’s probably not a deal breaker in your eyes. When you compare $58 to $4,000, it seems like a no-brainer. But, let’s extrapolate the numbers out a little more.
That $58 per month costs you $696 per year. If you were to keep the loan for the entire 30 years, you’d pay $20,880 more in interest! Suddenly that $4,000 in closing costs doesn’t sound so bad.
WHEN DOES A “NO CLOSING COST” LOAN MAKE SENSE?
Now it might seem like it never makes sense to take a “no closing cost” loan. Why would you subject yourself to that much more interest? However, there are situations when it does make sense.
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You need to consider your plans for the future. Ask yourself the following questions:
- Is this your forever home?
- If so, do you see yourself refinancing in the near future?
- If it is not your forever home, when you do you plan to move?
Ideally, you want to refinance or sell the home before you pay more than an additional $4,000 in interest. Here’s how it works:
$4,000 (closing costs) / $58 (higher payment difference) = 69 months
Rounding up, it seems if you live in the home for more than 6 years, the higher interest rate would cost you more than the $4,000 in closing costs.
Let’s say you live in the home for 10 years. You’d end up paying $5,800 extra, that’s $1,800 more than the closing costs would have cost you. In order to avoid paying more than your closing cost savings, you’ll need to determine if you’ll still be in the home after the break-even point. If so, paying the closing costs may make more sense.
NEGOTIATING CLOSING COSTS
Luckily, a “no closing cost” loan isn’t the only option. If you think this is your forever home or will be in the home longer than your break-even point, you can negotiate your closing costs. There are several ways to do this:
- Work with one lender and inquire about lower costs. Sometimes lenders are willing to lower some of the costs in order to keep your business. If they know you are shopping around, this is a likely option.
- Shop around and find a lender that will charge less for your loan. Every lender has a different fee structure.
In order to negotiate your closing costs, though, you’ll need an attractive loan application. Try maximizing your credit score, keeping your debts as low as possible, and applying only after having consistent and stable income/employment.
Having good qualifying factors will give you the most leverage when negotiating your loan terms. Of course, you should explore all of your options. You may find that a “no closing cost” loan provides you the most savings in the end. It depends on the difference in the interest rate a particular lender will charge. Exploring all of your options will let you know the best option for your situation.