What is a no closing cost mortgage?

No closing cost mortgages are mortgages in which you do not have to show up at the closing table with any cash of your own. Usually, this is accomplished during a refinance, purchase mortgages can be setup to also be done as a no closing cost mortgage, it is just not as easily available for a purchase mortgage.

When I say no closing cost mortgage, that’s exactly what I mean. No origination points, no discount points, no fees what’s so ever. While the money the broker makes will still be the same, you are agreeing to take a higher interest rate to help pay those costs you normally would pay with a normal mortgage transaction. You will have to cover prepaid items however, like your prepaid interest to cover the interest cost until you make your first mortgage payment as well as the tax and insurance payment requirements if needed. These are not fees or costs, but they are normally covered when you make your monthly mortgage payment.

On a refinance, if your previous mortgage was holding your tax and insurance payments in escrow, while you would pay the escrow during your closing transaction, after the prior loan gets paid off and they process the payment, the old mortgage note holder will then usually issue a check to you with your escrow balance. So in the end, you only make a payment for the interest that would be owed between closing and your first mortgage payment.

As an example, if you close on your mortgage on the 15th of the month. The mortgage company is not going to let you have that money for free. So for the prepaid interest, you are actually making the interest payment from the 15th until the end of the month so that when you make your first mortgage payment, the interest has been covered with your prepaid interest. Needless to say, your going to pay for it one way or another, you just prepay it at the closing table.

When figuring out the interest rate for your mortgage, the bank or broker will have a rate sheet. What that sheet shows is the different interest rates the bank offers and how many points the different interest rates costs to get all the way to 0 points. On the other side of that 0 points however, are the points that a bank will give a broker to get the customer, that is you, to take a higher rate. So for instance, if 5.0% is zero points, well, then 4.75% may cost you 0.875% in points to lower your rate. On the flip side, if the broker can get you to take a 5.25% at 0 points, then the bank may pay the broker 0.25% of your mortgage.

For illustration purposes, this is what I mean.

Interest Rate	Points
4.75%	0.875%
4.875%	0.25%
5.0%	0%
5.125%	-0.125%
5.25%	-0.25%

So using the table above, you can see that for the higher interest rates, the bank will rebate money back to the broker for the higher interest rate. If you wanted a lower interest rate, you can see how much it would cost you as a percentage of your loan amount to get that lower interest rate. If you are dealing with a broker, the broker may change the figures above to allow them to make more money off of your mortgage.

Note: These numbers are just examples and therefore should not be taken as gospel, not to mention the fact that rates can and do adjust throughout a business day as well.

Now, how you can potentially get that no closing cost mortgage or refinance is, instead of taking the 5.0% 0 point interest rate, you could potentially take a 5.5% mortgage interest rate and the rebate is shared between you and the broker to lower you closing costs or give you that no closing cost mortgage your looking for. There are of course drawbacks to this option, you are paying a higher interest rate and therefore more in interest each month. If you are not going to hold the mortgage for a long period of time however, a no closing cost mortgage could potentially make sense. It limits your closing costs and it allows you to get a lower interest rate than what you may have been paying earlier.

The no closing cost mortgage also gives you the flexibility in a falling interest rate environment to refinance as much as you want because ultimately, you do not have to worry about closing costs and you don't have to concern yourself with payback periods because as soon as you make your first payment, you are saving money, unlike others who may have had closing costs. There are many different ways of acquiring a no closing cost mortgage as well. The statements I made above reference a typical mortgage that most everyone is aware of.

The other potential option is to get a Home Equity Loan, or HEL in industry parlance, offered by an institution with no closing costs. You use the proceeds of the HEL to pay off your traditional mortgage and the HEL then jumps into first position and you only pay the HEL as your monthly mortgage payment. As an example, Pen Fed currently is offering a no cost HEL for 4.99% on a 20 year payback period. This would allow you to get that potential lower interest rate for no cost.

You could also use the higher interest rate to get a lower closing cost with a shorter payback period instead of going with a true no closing cost mortgage. This still provides flexibility, but not as much flexibility as a true no closing cost mortgage would. So instead of paying 2-3 thousand in closing costs, you could choose the rate which allows you to pay for instance, only 1k in closing costs, in addition to your prepaid items.

The drawback to a no closing cost mortgage is you give up the ability to get the lowest interest rate and therefore pay less in interest and lower payments. For most people however, this should not be a problem seeing as how the average homeowner moves every six years per the National Association of Realtors. If you cannot break even prior to two years however, it would probably be best to limit your closing costs as much as possible. If you plan on staying in your house longer than two years, then it may make sense to pay closing costs and get that lower interest rate. If your not sure as I currently am, then stick with the no closing cost mortgage because it helps keep money in your pocket until you figure out what your going to do.

With a no closing cost mortgage, this allows you to keep money in your pocket and get a relatively good rate. Not necessarily the BEST mortgage rate out there, but it allows you to lower your rate for very little cost if you are looking at refinancing and lowering your payments. While a no closing cost mortgage will give you the lowest interest rate, the option does have it’s positive aspects and has a place when financing or refinancing your house.