No-Cost Mortgage Loans…What’s the Catch?

Isn’t a no-cost mortgage better than a low-cost mortgage? In theory, it sounds good, right? No-cost mortgages have gotten quite a bit of exposure lately, and I will explain how the two differ. First, we must understand what an interest rate is, compared with the APR (annual percentage rate). The APR blends the closing costs (where the straight interest rate does not) with the loan amount and re-amortizing that figure over the term of the loan. On traditional loan financing, the APR is usually within .125% of the actual note rate tied to the amount borrowed.

When comparing loans, the APR is the best comparative tool, not the interest rate. The APR has no bearing on your principal and interest payment amount nor the note rate. APR is a barometer of loan cost solely. The interest rate determines the monthly mortgage payment.

A No-Cost Mortgage is truly a “no-cost” loan — no appraisal fee, no lender fees and no closing costs. These fees are assessed by virtue of taking out the loan. The mortgage lender provides a credit at the close of escrow equal to the amount of the closing costs, thereby creating a “no fees” loan. So what’s the catch? No-cost mortgages will contain a higher interest rate and APR, so you’re in essence amortizing the closing costs over the life of the loan (i.e. 360 months representing a 30-year fixed rate mortgage). So yes, you are still paying the closing costs, but just in a different way.

A Low-Cost Mortgage is a traditional mortgage all lenders offer that is considered the norm. You take out a loan while paying any applicable fees associated with doing so, excluding discount points, which are usually optional. Low-cost mortgages will contain lower rates than their no-cost mortgage counterparts. Here the lender does not have to inflate the rate for generating overage to pay the borrower’s closing costs. Thus you will get better pricing when it comes to the interest rate and terms. Thus, in general, the interest rate and APR are lower on low-cost mortgages than on no-cost mortgages.

So what is better for you?
The benefits you would gain from either choice depend on how long you plan to hold the loan and your financial goals. For example, because the future for many is unknown in terms of how long the loan will be held for and/or how long the property will be held for, a low-cost mortgage is a more appropriate long-term strategy as the realized benefits of the lower cost mortgage materialize over time — i.e., lower interest savings over the life of the loan. But if the property hold time or the loan payoff is going to be dramatically shorter, such as within the next 12 months, a no-cost mortgage is more appropriate (despite the higher interest rate.).


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5 Responses to “No-Cost Mortgage Loans…What’s the Catch?”

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  5. […] it comes home loans, there are many types to choose from. Figuring out which loan is best for your new property […]

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