If your loan officer were to offer you a no closing cost mortgage in order to refinance your mortgage, would you think it was a scam? It does sound too good to be true, but there is such as a thing. Despite its name “no closing cost,” you are going to be paying those closing costs, just in a different way. There are several ways that this loan can be written; you can pay the costs by taking a higher interest rate or by financing the closing costs right into your mortgage, taking a higher principal amount. Either way the lender is still making the same amount of money; the main difference is how you pay for them.
Closing Costs Buried in the Interest Rate
Paying closing costs in the interest rate is one way that lenders get around charging closing costs to customers that do not have the cash to pay them up front. This is done by charging you a higher interest rate than you qualify for based on your credit, income, loan-to-value and debt ratio. The amount that your interest rate will increase depends on the amount of the closing costs that are being paid for by the lender. Because every lender charges a different amount of closing costs and rates change on a daily basis it is impossible to predict how much higher your interest rate will be unless you talk to your lender.
Rolling the Closing Costs into the Loan
Another way to avoid paying closing costs at the closing is to roll them into the loan. This option will not be possible for every borrower, though. It depends on several factors including your current loan amount without the closing costs and your current loan-to-value ratio. If your LTV is close to the maximum amount allowed for the program that you are in, then you might not have the room to roll the costs into the loan. If rolling the closing costs into your loan will put your LTV over 80 percent it might not make sense to do it because then you will be stuck with private mortgage insurance until your LTV comes back down.
Who Needs a No Closing Cost Loan?
There are positives and negatives of the no closing cost loan, just as there are with any loan. Anyone can take advantage of them, but it makes sense to do the math before committing to any type of loan. If you do not have the cash to pay the costs up front, yet you know that you could lower your interest rate by a point or more by refinancing, it is generally worth it to refinance. If you do have the cash to pay the closing costs, you can figure out how much you would save by paying the closing costs yourself. This would allow you to determine how many months it would take for your savings to add up to the amount of the closing costs that you are paying. If you know that you will only be staying in the home for a few more years, it is almost always worth financing the closing costs into your loan as you will not be in the loan for the full term to make your money back.
It is important to remember that by taking a no closing cost mortgage that you are paying higher costs in the end. Your closing costs remain the same but by increasing your interest rate or financing the closing costs with your mortgage, you are paying for the closing costs over a longer period and with more interest added onto it. As long as you determine that the savings are worth it in the end, a no cost mortgage can be worth looking into for your next refinance.
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