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No Closing Costs Loans

We have all heard about the "no points mortgage" or "no closing costs loan". How do lenders offer these programs? Simple Ė the interest rate is higher than a loan that includes points or Closing Costs. Are these programs bad? Not at all. But they might not be the right deal for you.

One of the most misunderstood concepts is the relationship between interest rate and Closing Costs. The important thing to remember is that the higher the interest rate on a specific loan, the lower the Closing Costs. And conversely, the lower the interest rate, the higher the Closing Costs.

Before we figure out which is better for you, we must understand that some consumers may not have a choice. You may need the lower interest rate in order to qualify for the loan, in which case a loan with a lower interest rate and higher amount of Closing Costs is the only answer. Or you may be short on cash or unable to "roll" the Closing Costs into the loan amount, which means that a loan with a higher interest rate and lower amount of Closing Costs is the right situation. But you may have a choice, and it is worth doing a few simple calculations to determine the right deal for you.

In order to determine which is best for you, have the lender provide you with a couple of choices with different interest rates and their corresponding Closing Costs. (Make sure that the choices are identical except for interest rate and Closing Costs.) Ask the lender to translate the different interest rates into monthly payments. Next do the following two calculations:

  1. Subtract the difference in the payments and the difference in the Closing Costs.

  2. Divide the difference in the Closing Costs by the difference in the payments.

The result is the number of months it will take to realize the benefit of the lower rate/higher cost alternative. If you anticipate maintaining the mortgage for more that this time frame, the lower rate/higher cost alternative makes sense. If you donít, the higher rate/lower cost alternative makes sense.

EXAMPLE

LOAN AMOUNT: $100,000

INTEREST RATE: 6.75%; PAYMENT: $649; CLOSING COSTS:  $2,500

INTEREST RATE: 7.25%; PAYMENT: $725; CLOSING COSTS:  $500

In this example the difference in the loan payments is $33 a month and the difference in the Closing Costs is $2,000. It will take 60 months (5 years) to realize the benefit of the lower payment (2,000 divided by 33). Thus, if you plan to maintain your current mortgage for less than 5 years, the higher interest rate/lower Closing Costs alternative is the right deal for you.

For some consumers it is difficult to predict how long they will maintain their mortgage loan. For others, it is easier. One item to keep in mind is the average time that the typical consumer maintains their mortgage loan is 5 years.

 

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