No-Closing-Cost Mortgage: What It is, How it Works

Fact checked by Betsy PetrickReviewed by Lea D. UraduFact checked by Betsy PetrickReviewed by Lea D. Uradu

With a no-closing cost mortgage, the borrower doesn’t pay closing costs at closing. Instead, the closing costs are rolled into the balance of the loan, or the lender will charge a higher interest rate on the mortgage.

Closing costs typically include lender fees, recording fees, taxes, home appraisal costs, and more. A borrower can usually expect to pay a few thousand dollars in closing costs. If they opt for a no-cost mortgage, sometimes referred to as a no-fee mortgage, they’ll save money at closing but pay more throughout the loan.

Key Takeaways

• Closing costs refer to expenses from buying or refinancing a home.
• A no-closing-cost mortgage is for a new home or refinancing, where all closing costs are rolled into the balance or interest rate of a loan.
• You’ll end up with a higher interest rate and probably a bigger mortgage, so this won’t be a good choice for everyone.
• Choosing how to pay your closing costs is an important part of deciding whether you should refinance or not.

What Are Mortgage Closing Costs?

When you take out a mortgage (either for a purchase or a refinance), you’ll pay various expenses, most of them listed here in our closing cost guide. Some of the most common include:

• Lender fees
• Government recording fees
• Setting up an escrow account for taxes and insurance
• Costs for a home appraisal

Pay careful attention to the breakdown of your closing costs to avoid paying for unnecessary items.

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 where you don’t pay any closing costs at the time of the loan’s release.

While having zero or low costs at the time of closing sounds great, don’t forget that if something sounds too good to be true, it probably is. You’re still going to pay those costs—in the future.

Most terms of your mortgage are negotiable, so how these costs are paid is up for discussion between you and your lender. Lenders and mortgage brokers don’t work for free, so many of these items still need to be accounted for. 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. The other way is by charging a higher interest rate to do a no-closing-cost refinance.

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 if you should refinance is to run the numbers. Look at the total one-time closing costs that you’ll have to pay, then compare that number to the amount you’ll save each month with your mortgage payment. If it costs you $2,000 to refinance and you save $200 with every payment, then you’ll pay back those costs in 10 months.

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 examine how rolling the closing costs into your loan affects your monthly payment. You’ll want to ask questions 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 also help inform your decision-making process. While you never know when your situation can unexpectedly change, a refinance makes less sense if you already know that you’re planning on moving in a few years. Since most refinances have you pay some up-front costs in exchange for lower monthly payments, if you plan to stay only briefly, then making back those initial costs will be difficult.

Do Closing Costs Include the Down Payment?

No, closing costs are separate from the down payment. They include lender fees, government recording fees, home appraisals, and fees for setting up an escrow account.

Do I Have a Choice About How To Pay Closing Costs?

Yes, your lender will discuss closing costs and will usually give you the option to roll them into your loan’s balance or pay them at closing.

How Much Are Closing Costs?

According to Fannie Mae, closing costs are usually 2%-5% of the value of your mortgage. For example, if you’re purchasing a $300,000 home and putting down 20%, your closing costs will range from $7,000 to $9,000.

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. See what the deal will cost and how much you’ll save each month. That will help you make the best financial decision for your situation.

Read the original article on Investopedia.