October 14th, 2010 11:49 AM by Richard T. Cirelli
Understanding the “No-Cost Loan”
Just like there is no free lunch, there really is no such thing as a true “no-cost” loan. But, it is possible to get a loan without coming out of pocket for closing costs, points and other expenses. Let me explain how it works……
There is always a correlation between interest rate and the cost for a loan. All lenders should (whether a direct lender or a mortgage broker) offer all borrowers both a no-cost loan and a loan with standard costs to see which one is best for the client. It’s not hard to figure out and the answer varies according to how long the borrower keeps the property and the amount of cash that they have.
Let’s look at a simple example:
Let’s compare a $300,000 No-Cost Loan to one with standard Closing Costs of $3000 and also to a third loan with standard closing costs plus a cost of 1-point. Figure that the standard closing costs are $3000 and include Escrow, Title Appraisal and Lender Fees. If the borrower is paying a point, this would add an additional cost of $3000.
No-Cost Loan
Standard Cost Loan
1-Point Loan
Loan Amount:
$300,000
Interest Rate
4.50%
4.25 %
4.00%
Monthly Payment
$1520
$1476
$1432
You can see that the “No-Cost” Loan comes with a higher interest rate than a loan where the borrower pays for the closing costs. And, if the borrower is willing to pay a point (1% of the loan amount) in addition to the closing costs, the rate goes down even further.
Now, let’s look at the cost of each loan over time. The chart below shows the total cost of each option over the 30-year life of the loan.
Total of all Payments:
$547,200
$531,295
$515,609
Total Interest Paid:
$247,220
$231,295
$215,609
Initial Cost of Loan:
$0
$3,000
$6,000
Net Savings:
$12,925
$25,612
Now you can see that the no-cost loan costs less up front but over time, a loan with a lower interest rate and lower payments saves the borrower considerable money when compared to the loan with no costs.
When deciding which option is best for you or your clients, it is helpful to know the Break-Even Point in time. In this example, the Break-Even Point is 4 years. So if the borrower intends to keep the property and the loan more than 4 years, they are better off paying closing costs. And, if they pay a point too, the savings is even greater over time.
As a mortgage professional and Certified Mortgage Planner, I provide an in-depth Analysis for all clients. It’s important to make the right choice up front since it could be one that you live with for 30-days.
Mortgage Rate Update:
Rates held fairly steady over the past week. All the talk is about the timing and extent of the next round of Quantitative Easing by the Fed – the answer of which we expect of know after the next scheduled Federal Open Market Committee meeting on November 3rd.
The question is “are slightly lower rates even what is truly needed to boost consumer demand and create jobs? Rates are pretty low as they stand right now...so why do more easing? It’s probably to devalue the Dollar, and boost our economy through making our exports relatively cheaper for foreign buyers. So while another round of quantitative easing might provide an initial decline for interest rates – the devaluation of the Dollar will drive rates higher, thereby mitigating the lower rates.
In the meantime, rates are still ridiculously low.