When to Opt for a No Closing Cost Mortgage

You’re about to purchase a property and have settled on a 30 year fixed rate mortgage.  Now is a great time, rates are at historic lows.  But did you know there’s an option as part of this purchase that has you paying less up front for the purchase, and potentially less overall?

At the closing there are many costs incurred to enable and record the sale legally, both for yourself and for the mortgage company.  Here is an example list of those fees with rough amounts paid in prior purchase transactions:

Closing Cost Component Amount
Property Appraisal $500
Real Estate Attorney Fee $500
Title Search $250
Courier Fee $50
Plot Plan $175
Recording Fee – Deed $125
Recording Fee – Mortgage $175
Recording Fee – Homestead $100
Credit Report $40
Tax Service $75
Flood Certificate $12
Lender’s Title Insurance $1200
Total Closing Costs $3,202

From here forward, for easy math, I’ll assume a $3,000 closing costs amount.

Now to put these closing costs in perspective, let’s imagine we’re buying the following home with mortgage terms:

Home Financial Detail Amount
Home Value $500,000
Down Payment $100,000 (20%)
Mortgaged Amount $400,000
Available Mortgage Terms 4% 30 year Fixed Rate

 

Borrower options

There are three options of how to handle these closing costs for comparison:

  1. Pay closing costs out of pocket
  2. Roll closing costs into the loan amount
  3. Lender pays the closing costs (results in a rate increase of 0.125%)

 

Option 1) Pay Closing Costs out of Pocket 2) Roll Closing Costs Into Loan 3) Lender Pays Closing Costs
Summary of Impact Lost liquidity, can’t invest in stock market Loan amount increases, rate stays the same Loan amount stays the same, rate increases by 0.125%
Closing Costs Paid Up Front $3,000 $0 $0
Rate 4.00% 4.00% 4.125%
Loan Amount $400,000 $403,000 $400,000
Monthly Mortgage Payment Amount (Principle + Interest) $1,910 $1,924 $1,939
Closing Costs Market Return Monthly ($3k earning * 6% annual / 12 months) $0 $15 $15
Real Monthly Net Mortgage Payment $1,910 $1,909 $1,924

 

Takeaways

First, let’s comparing paying closing costs out of pocket and rolling closing costs into loan:

  • After taking into account the market returns of the closing costs, the real monthly net mortgage payment from this analysis would be nearly the same for either circumstance.
  • If either of these options are plausible, the consideration of which option to pick would be based on projected market return rates and personal need for liquidity.  If a borrower thought they could get greater than 6% market returns with the closing costs, they should opt to roll the closing costs into the loan.  Otherwise, they should opt to pay closing costs out of pocket.

 

Next, let’s compare options 2 and 3, rolling closing costs into the loan, vs the lender paying those closing costs in exchange for a 0.125% higher mortgage rate.

  • The real mortgage payment amounts after taking into account the market returns of $3k closing costs invested are $1909 and $1924 respectively, a difference of $14 per month.
  • With the lender paying the closing costs, the closing costs are not included as part of the cost basis of the home since they never need to be repaid.  Accordingly we should compare the time length of mortgage payments where the increased rate underperforms.  It would take ($3,000 closing costs / $14 cost increase) 215 monthly mortgage payments for the increased rate to cost the borrower the same amount.
    • 215 months is roughly 18 years.
    • Based on survey’s the average homeowner stays in their home for 13 years.
  • So long as the borrower intends to stay in the home for 215 months or less, they should opt for the lender paid closing costs option.  If the borrower intends to stay in the home for more than 215 months, they should opt for rolling closing costs into the loan.

 

This analysis was based on a plausible loan amount and circumstance.  While every circumstance isn’t the same, a borrower could apply this same analysis to their mortgage amount and situation to determine the best choice for them given all of the options.

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