“If it looks too good to be true, it probably is.”

 

It seems that about once a month, I get something in the mail offering Lana and I a “No Closing Cost” Mortgage… I did a bit of a Google search and came up with this article written by Juan Boldizsar. He did an outstanding job in answering the question and I thought many of you would find it interesting and easy to understand. Enjoy!!

Here is the full article: http://www.mortgagenewsdaily.com/wiki/Contributors.asp?pID=24890

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 If it looks too good to be true, it probably is. Let me explain… Even if we omit the lender’s fees that get charged in connection with a mortgage, there are still third party fees, e.g., title examination and insurance, closing fee, recording fee, flood determination, appraisal etc. None of these parties give away their time, resources or services for free, nor does the mortgage broker or the retail lender who arranges your loan for you. The money to pay these people has to come from somewhere.

Here’s how it works. Banks and mortgage companies make lots and lots of loans. They pool them together and use them as collateral for loans that they get from institutional investors. This process is referred to as “securitization.” The loans they get are in the form of bonds that they sell in the financial markets, i.e., Wall Street. When the institutional investors like hedge funds, pension funds, insurance companies etc. buy these bonds, they expect a certain return on their investment. This rate of return is referred to as the bonds’ yield. This describes the rate of interest that the investors earn from these bonds.

 So, if a lender figures that on a given day, they can borrow money at 6%, lend it at 7% and cover their overhead and make a reasonable profit, the rate you will see advertised in the paper will be 7%. If they have to pay your closing costs they have to charge a higher rate if they still want to be able to cover their overhead and generate money for their shareholders. By charging a higher rate, they get paid more for the pools of loans that get turned into bonds. That extra money is used to pay your closing costs when you get one of those “no closing cost” loans.

All of that being said, the important thing to know is not whether there really is such a thing as a “no closing cost loan” — because in reality, there isn’t — but rather whether what gets referred to as a “no closing cost loan” makes sense in your particular situation. For instance, let’s say currently have a loan that has a rate of 8% and you have a choice of refinancing into a loan with closing costs that carries a rate of 6% and one that has no closing costs and a rate of 6.5%. Assume that the difference between the monthly payments is $100 and that for the loan with the lower payment the closing costs add up to $5000. By paying closing costs, you save a hundred dollars for every month that you keep the loan past month number fifty. On the other hand, if you plan on keeping the loan for less than 50 months, it doesn’t make sense to pay the closing costs because the total monthly savings don’t cover them.

Before we finish, let me make it clear that the numbers used in my example are for illustrative purposes only. When you are out shopping for a loan, you should consult with an experienced and knowledgeable mortgage professional. Ask that person to give you a “break-even” analysis so you can determine whether paying closing costs or going with a “no closing cost loan” makes more financial sense for your particular situation.

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For my clients, I will usually issue a few different Good Faith Estimates in order to examine the different types of loan programs we offer. Next, we’ll narrow down which program makes the most sense for the clients overall financial goals.

Once a program is decided upon, we will look at a few different Good Faith Estimates with different rates and fees for the same program. That way, it is clear what, (if any) benefit will result in paying down the rate in the form of points, or the extreme opposite of raising the rate to pay for the loan and 3rd party fees.

Generally speaking, I do not recommend paying points to lower an interest rate, unless the borrower is positive they will be keeping the loan long term or the property is an investment. However, I also do not typically recommend “no cost” loans because of the amount that the rate must increase in order to pay the fees…

I feel that with experience and proper mortgage planning comes finding that “happy medium” required to put together the perfect loan.