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One of my Realtor® clients
called me last week. "Aaron,
I want to refer my client to you but they say
they have a lender who is offering them a 'no-cost'
loan and they don’t have to pay any closing costs.
Is this real? Can you match it?"
The
answer is "Yes, I can
match it." The bigger question is
"Are they sure this is what they want?"
First of all you need to determine what
they are being promised.
Most lenders who offer “no-cost” mortgages are talking
about their lender fees, not
those fees associated with title, escrow, taxes, reserves, impounds,
prepaid interest, etc. Led
by Internet lenders, the term "no-cost" mortgage is something we
now hear all of the time.
As
you know, not many things are
free. This is no exception.
There is simply
no such thing as a "no-cost"
mortgage.
Mortgage companies are
obviously not in the business of doing
free loans. You will always pay your closing
costs one way or another.
OK, so then how do they do it??
If you don't pay your
closing costs in cash at the closing, you
are simply going to pay it in the future by accepting a
larger loan amount or an above-market interest rate.
For
example: There are some banks and brokers that offer programs like
107% financing. You have seen the billboards and ads. This means
if the home you are buying is $300,000, they will loan you up to
$321,000. Obviously, this more than covers all of your closing
costs, including your impounds, reserves, taxes, title, escrow fees,
etc.
On
average, closing costs, including everything
I just listed, are around 2.5-3.0% of the loan amount. Lender's
fees usually average about 1.0-2.0% of this
total amount.
IMPORTANT NOTE: Special circumstances can make both of
these "average" numbers I just quoted much higher.
It
sounds great!! You don't have to pay one dime out of your pocket!!
However, these products almost always carry a much-higher interest
rate and the loan products are limited. You are not likely going to
get a 107% loan on an interest-only ARM. In addition, you are
going to pay $10,000's, if not over $100,000, of additional interest
over the life of the loan simply because you did not pay cash for
the closing costs.
The
next way to get you a "no-cost" loan is by the broker or bank
raising your interest rate to a higher level than you would normally
get if you were paying the closing costs yourself. They get a
bigger fee and pay your closing costs for you. It may sound great
but it's usually a bad financial decision and the advertisers of the
"no-cost" mortgage rarely give you the details.
This
does not mean I am against "no-cost" mortgages. On the contrary, I
believe in some situations they may be the only way to get the deal
done. In that regard, it can sometimes make sense. However, it is
important to understand what you are getting into.
Remember mortgage brokers find someone to loan you the money to buy
your home. They collect a fee from
this party when they complete the transaction.
The fee they collect is called a “Yield Spread Premium.”
In order to pay your settlement charges on a “no-cost”
mortgage out of this fee and have enough left to compensate
himself, the
broker will need to make sure the fee he collects is big
enough to cover all of these charges.
Keep in mind, in this scenario, we are
not likely talking about third party fees like escrow, title, and
taxes nor are we talking about prepaid interest charges, impounds
and reserves. We are just talking about the lender's fees. To get
a "no-cost" mortgage will usually mean
a higher interest rate to you to increase the size of his fee
from the lending bank to make sure
he covers your costs and his fee.
Mortgage bankers, like here
at Realty Mortgage, deal directly with borrowers.
We often have the
ability to do the same thing, except there is no YSP.
In certain situations, we may
be able to increase your rate in order to help
you cover the costs associated with closing and
to offer you a “no-cost” loan.
However, we rarely recommend that you do this.
Rates
are always changing. Therefore, it is difficult to give you a very
firm example of the additional costs associated with this. Most
lenders would agree with me that you can probably expect to pay an
interest rate of .500%-2.000% higher on your loan if you want your
closing costs covered. Sometimes it can be less. It will always
be higher than if you were paying these costs yourself.
On a
$300,000 loan, the difference between 6.000% and 7.000% is around
$200/mo. If the lender's fees on this loan were on the high side
of $4500, it will take you 23 months of this payment for this to be
a negative situation for you and your family. You have 307 months
to go and this does not include the additional interest
compounding.
The bottom line is go
with your instinct. You know there are no free rides and there is
not one here either. Borrowers usually
pay handsomely pay for a "no-cost" loan by accepting a higher
interest rate than they would if they paid their own closing costs.
Once again, some of the loan programs that would be available to
someone paying their own closing costs may not be available.
Most
lenders and financial advisers agree that “no-cost”
loans, unless you plan on being in that home less than two years,
make very little sense.
If you
don't have access to the money required to close, and you have no
way of borrowing it from a family member or someone close to
you, and you are absolutely in love with the home, then consider it. Just
keep in mind, that "no-cost"
loans are usually
a bad long-term financial
decision, and you are likely going
to pay a premium price for this decision.
Real
estate salespeople should understand the best way for you to help
your "cash-strapped" client in this situation is to aggressively
negotiate some closings costs from the seller. Obviously this works
best in a buyer's market like we are experiencing now then in a
seller's market like the one we dramatically experienced throughout
most of 2004. |
