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One of the most confusing areas for consumers in a mortgage loan transaction
are closing costs. Here I'll explain the advantages and disadvantages of the highly advertised "zero cost" or "low cost "loans.
First and foremost, there is no such thing as a zero cost loan! Everyone knows there are costs associated with getting a mortgage loan; appraisal, credit reports, state taxes, county recording fees, title companies fees, lender fees, escrows, and more. Someone has to pay these fees, and it is always YOU. How you pay them is what this article tries to explain.
In a no lender fee or zero cost loan, the lender uses "negative" points to offset
your costs. In the example below, by having the 8.00% rate (versus the 7.5% rate), you
can reduce (or offset through interest rate) $2,000 of closing costs. By choosing
this option, it appear as if you saved thousands in closing costs. GREAT! But
while lower costs always sounds good, you now have a significantly higher interest rate!
OK, now what?
No matter what anyone says, a zero cost, or no lender fee loan is NOT automatically a great deal. Although it may sound so much better than paying thousands in closing fees, you have to analyze each individual loan and client situation to determine the benefits. Many lenders speak highly of the "thousands of dollars" you save in fees. They never discuss the fact that you may spend significantly more in interest over the full life of the loan than you ever saved in up-front closing costs! In the example below, you can pay $64,474 MORE in interest to save $4,000 today on a 30-year loan.
View the following chart, then call us. We'll run your personal numbers. Then you can decide if a zero cost loan is right for you.
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OK short-term
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OK short-term
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| Considerations on a $200,000 - 30 year fixed loan | Closing Costs Paid Out of Pocket | Closing Costs Added to Loan | Low Lender Fee Loan | Full No Cost Loan |
|---|---|---|---|---|
| Loan Amount | $200,000 | $204,000 | $202,000 | $200,000 |
| Interest Rate | 7.50% | 7.50% | 8.00% | 8.75% |
| Principal & Interest Payment | $1,398 | $1,426 | $1,482 | $1,573 |
| Closing Costs On Estimate | $4,000 | $4,000 | $2,000 | $0 |
| Out of Pocket Closing Cost Paid | $4,000 | $0 | $0 | $0 |
| Interest Paid over 5 years | $75,182 | $76,685 | $81,038 | $87,830 |
| Interest Paid over 10 years | $143,443 | $146,311 | $155,133 | $168,901 |
| Interest Paid over 30 years | $305,475 | $311,583 | $333,663 | $368,474 |
FACT: In a refinance loan, the vast majority of people roll the closing costs into the new loan.
A common misconception is that a zero cost loan is better than adding thousands of dollars in closing costs to the new loan. THIS IS NOT TRUE! Even if you were to only stay in the property 5 years, why have the higher payment when a few thousand dollars added to the loan principle is usually meaningless in the grand picture.
The general fixed rate loan "no cost" formula is that for every 1/8th percent increase in interest rate, you can usually eliminate 1/2 percent of the loan amount in cost. So on a $100,000 loan, by increasing the interest rate 1/8th, I can reduce $500 in closing costs. By increasing the rate 1/4 percent, I would reduce closing costs by $1,000. This DOES NOT apply to ARM (adjustable rate) loans.
I hope this article has helped you to understand the varied measures used to determine the advantages and disadvantages of zero cost loans. Each borrower is different, and the evaluations must be made on a case-by-case basis. As you can see, there are many factors to consider when looking at the available options. With us as your personal Mortgage Consultants, we will be able to answer all of your questions, outline the costs and benefits, and even give you a few new ones to consider! Of course, if a zero cost loan makes sense for your case, we will be happy to do one for you.
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Joe Metzler,
MMS,
UMB |
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Email
Us
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Equal
Housing Lender - Our services available only for properties
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