 Personal Finance PowerPoint Presentation What is a No Closing Cost Mortgage? Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia, where you can go for more references, resources, continuing your research from there. This is by Dan Miller, updated December 31, 2021. What is a No Closing Cost Mortgage? With interest rates at historic lows, you may be thinking about refinancing your mortgage. Now interest rates were at a historic low in 2021. They look like they're on the rise at this point in time. You will typically spend a few thousand dollars in closing costs as part of the transaction. So if you were to refinance, you typically have the closing costs that you're going to have to deal with. Those closing costs can include lender fees, recording fees, taxes, home appraisal costs, and more. So those are going to be the closing costs we're talking about. So what are we talking about when they say, what is a No Closing Cost Mortgage? Which is a little bit deceptive of a term. I'll just point that out now. In a No Cost Mortgage, sometimes referred to as a No Fee Mortgage, the lender absorbs the upfront costs by either raising the balance of the loan or charging a higher interest rate. So if we're talking about these costs, it's not like the costs go away, but we can imagine different ways that we can deal with the costs. We can say, okay, I can pay the costs at this point in time for the closing costs of the refinancing process. I can pay these fees. Or is it possible maybe I can just simply increase the loan balance for those costs? So now you're going to refinance the loan and you're going to increase or absorb those costs into the higher loan balance. That means I'm going to have a higher loan balance that I'm going to pay over the remaining portion of the loan, the loan term. And of course I'm going to pay interest on it as well. So now I've got the costs involved and I'm going to have to, I financed them in essence and I'm going to have to pay interest on it. Or we can imagine, what if I keep the loan balance the same, but I increase the interest rate to compensate for it, which gets a little bit more complex to kind of visualize. You can say, okay, I would have got a better rate, but now you're going to increase the rate a little bit and that's going to basically compensate for the fact that I'm not paying for the closing costs. So those are the ways that you can imagine to deal with the closing costs in different ways. So what are mortgage closing costs? When you take out a mortgage, either for the purchase or a refinance, you'll pay a variety of expenses. Most of them listed here in our closing cost guide. Some of the most common include, you got the lender fees, you got the government recording fees, you got the setting up an escrow account for taxes and insurance, the cost for a home appraisal. What is a no closing cost mortgage? Generally, closing costs are paid when the loan is released to the borrower. Some are paid by the seller with most paid by the buyer. A no closing cost mortgage is a purchase or refinance when you don't pay any closing costs at the time of the loan's release. So again, it doesn't mean like they magically disappear per se. It means we're going to be dealing with them in a different way and possibly if you don't have the cash flow to pay the closing costs, then you might still be able to go through the process and possibly treat them in some other ways such as including them or increasing the loan balance. Well, having zero or low closing costs at the time of closing sounds great. Don't forget that if something sounds too good to be true, it probably is. So again, a no closing cost, bit deceptive, very deceptive I think of language because it makes it sound like you're going to get some deal where they're just not going to have closing costs. I mean, how are they going to pay for the process of doing it? So you're still going to pay those costs in the future. So most terms of your mortgage refinances are negotiable. So how these costs are paid is up for discussion between you and your lender. So obviously, we're coming up with a loan kind of agreement here. We can imagine many different terms of the loan. We often think of loans as being fixed like they have to be this fixed type of loan. That's how it works. But that's just the standard we can deviate from those standards if we choose to and you can come up with more creative ways to deal with some issues such as I have a cash flow issue. I can't pay these closing costs possibly. And so maybe the lender can then come up with another way like increasing them into the loan balance or something like that. Lenders and mortgage brokers don't work for free. So many of these items still need to be accounted for. So in a no closing cost mortgage lenders typically recoup these costs in one of two ways. One way is to add them to the principal balance of your new loan. So you were going to refinance the loan at 200,000 and now the loan is 200 and some thousand because we added the closing costs to it. That means that you're going to be paying interest on it. Of course, which I mean if you couldn't pay the closing costs might be a worthwhile deal. But that's something to factor in. The other way is by charging a higher interest rate to do a no closing costs right refinance. This one's a little bit more difficult to visualize. Like you got to work through the numbers to kind of see well how exactly does that like how high would the interest rate go to be comparable to the closing costs and so on. But that would be the other factor that you can tinker with, right? You can change in order to make this work. Should you refinance with a no closing cost mortgage? Whether to refinance your mortgage is a complicated decision and the answer may differ according to each situation. The best way to decide is if you should refinance at all is to run the numbers. Run the numbers. Look at the total one-time closing cost that you'll have to pay. So clearly when you're looking at the closing costs, they have to be a factor that you will be dealing with and compare that to the benefits of refinancing, which might be a lower rate than you currently have on there. So then compare that number to the amount you'll save each month with your mortgage payment. If it will cost you $2,000 to refinance and you'll save $200 with every payment, then you'll pay back those costs in 10 months. So you could do a quick kind of calculation on that to try to get like a payback period, which would simply be, okay, if I got to pay these costs up front $2,000 and I'm going to save each month $200, then you could do a quick division and get how long it's going to take before you get the payback of that. That's not taken into consideration time value of money. You could have more complex calculations than that, but that's a nice quick tool you can use. You can do the same sort of analysis when deciding if you should use a no closing cost mortgage refinance. But in this case, you also need to look at how rolling the closing costs into your loan affects your monthly payment. You'll want to ask questions like such as, is it worth it to me to pay $1,000 now to save $25 each month for the remainder of the term of my mortgage? Having an idea of how long you plan to stay in your current home can help inform your decision making process as well. So notice when you start to do these calculations like if you had a 30-year loan or something like that and you're like, okay, well, it's going to take me 10 months to pay it back and I'm going to be in the home for 30 years and paying this thing off. Then it becomes an easier calculation over the long term. But if you're saying, okay, I might move in like 10 months or a few years or something, then it becomes a little bit more difficult of a calculation to do. Or it could be a lot more difficult. So while you never know where your situation can unexpectedly change, if you already know that you're planning on moving in a few years, then a refine makes less sense. So clearly if you're refinancing, you're in some way paying for these costs, possibly paying them basically upfront. If you're going to move quickly, then the sooner you're going to move, the less beneficial the refinance looks because you paid up the upfront costs and you're not recouping the benefits because the benefits are going to be recouped over time over the years of the loan. So since most refinances have you pay some upfront costs in exchange for lower monthly payments, if you are planning on staying only briefly, then making back those initial costs will be difficult. So the bottom line, a no closing cost mortgage may seem like an amazing deal at first, but a closer examination reveals potential disadvantages for starters, closing costs don't go away. Those fees are just collected in the future, run the numbers. So just the name to me kind of makes me skeptical of it and not even want to engage with it because it sounds like when you hear that name, when I hear that name, it sounds like a deceptive kind of name. That doesn't mean that you shouldn't look into it, of course, but obviously you've got to run the numbers because you've got to think about what are going to be the pros and cons. It could be a beneficial situation if you don't have the cash flow possibly in that instance. So see what the deal will cost and how much you'll save each month. That will help you make the best financial decision for a future for your situation.