No Closing Cost Loan Myths

The "No Closing Cost" Loan
This is unquestionably the biggest myth circulating through the home finance arena today.   How can this be a myth you ask?   After all, you hear radio ads constantly purporting to offer these “no brainer”, no cost loans, so they must be real, right?   

Here’s my question. Which service do you think is willing to be performed for free so that you can obtain a loan? That’s right, none of them.   So, if you require all of these services, and no one is willing to work for free, who do you think pays them?   In one way or another, you do.  
So what is the “No Closing Cost Loan”?   Well, it’s a marketing strategy that, as to date, has not been fully challenged in the courts.   It has, however, been questioned and at least one major brokerage company has paid a hefty settlement to keep the case out of court.
So, how does it work?   If you read our section on “Fees” you know that one of the ways a mortgage broker gets paid is by offering you a rate higher than the rate the Lender/Investor is asking for.   In return, the Lender is willing to pay a premium (or commission) to the Broker for this higher rate.   In the case of a “No Cost Loan”, the rate the Broker offers you (the borrower) is high enough that the commission he/she receives is sufficient to pay all the “Closing Costs” associated with the loan (including the Broker’s Fee).
 
For example (and this is a real example) let’s say that after reviewing your loan application the Lender (not the Broker) is willing to offer you a $250,000 loan at 5.625% interest for 30 years with no points.   Of course the Lender does not tell you this they only tell the Broker.   They also tell the broker that if he/she can get you to agree to rate of 6.500% that they will pay the Broker a commission equal to 2.75% of the loan amount. Well, 2.75% of $250,000 is $6,875.00!   If your total fees for the closing attorney, appraisal, Lender etc are $2,500 (which is typical for a loan of this amount) then the Broker will pay these costs out of the $6,875.00 paid to him by the Lender.   Therefore his net “commission” would be $4,375.00.   Not a bad paycheck!  
But we just agreed that you are the one paying for these costs.   What did it cost you?   Well, you qualified for a 5.625% interest rate (Par Rate) which would give you a monthly payment of $1,439.14 but you ended up with a 6.500% interest rate with a payment of $1,580.17.   The difference is $141.03 per month.   Over the complete term of the loan this higher rate would equal $50,770.46 in additional payments!   So, depending on how long you keep the loan, it is possible that the “No Closing Cost” loan actually cost you over $50,000.   WOW, what a deal!
In a nutshell it works like this:   The Broker gets paid a commission from the Lender for selling you a loan with an interest rate higher than you qualified for (that’s called the “up-sell”) and from this commission he pays the other closing costs and pockets the difference.  
 
BUT WAIT- This Technique Does Have it’s Merits!
Depending on your financial situation, this technique can work to your advantage.   If you don’t have the funds to pay the closing costs or just don’t want to this is one way to cover these costs.   The primary concerns are how much over the “Par” rate you are paying and how much you are ultimately paying the Broker for his services.  
 
In spite of all the efforts of consumer advocates and governmental agencies to force full disclosure of Broker fees this, more often than not, does not happen.

 

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