Christina Pomoni asked:
‘No-cost’ mortgages often seem like a great deal for the most part because they don’t carry the closing costs that are typically around 3 to 5 percent of the loan amount. However, the truth of the matter is that all mortgages carry costs. The difference is that a ‘no-cost’ mortgage converts the upfront costs to costs paid over time at a higher interest rate. This means the borrower saves money now, but ends us paying more money in the long run.
Example
To illustrate better how a ‘no cost’ mortgage works and how it differs from a traditional mortgage we assume that a borrower is looking for a $200,000 mortgage at a 30-year fixed rate.
Lender A offers a traditional mortgage at 6 percent with $2,200 fees (including lender fees $600, credit report $50, appraisal $300, title insurance $800, Reconveyance fee $75, recording fee $45, wire & courier fee $55, endorsement feel $75, title closing fee $125, document preparation $30, other fees $45).
Lender B offers a ‘no cost’ mortgage with a rate of 6.5 percent.
Monthly payments:
Traditional mortgage (6.00%): $1,211
‘No-Cost’ mortgage (6.50%): $1,276
In simple terms, this means that if the borrower buys a traditional mortgage, he would have to pay $2,200 more upfront, but monthly payments would be $65 lower ($1,211 rather than $1,276). If he buys a ‘no cost’ mortgage, there are no upfront costs, but monthly payments are $65 higher ($1,276 rather than $1,211).
By buying the ‘no cost’ mortgage to avoid the upfront fees it doesn’t mean the borrower saves money. After 3 years (36 months) of paying that extra $65, he would have exceeded the $2,200 he originally saved ($65 x 36 = $2,340). Eventually, he will pay a lot of money in the ‘no cost’ mortgage, unless he chooses to refinance in three years.
The example assumes that, all things being equal, the only difference between traditional mortgages and ‘no cost’ mortgages are the upfront costs. However, in reality, not all costs associated with closing are waived in a ‘no-cost’ mortgage. ‘No cost’ mortgages do not carry processing fees and the appraisal and credit report fees, but they carry government taxes, homeowner’s insurance and any funds required for escrow. Therefore, they are not cost-free.
In particular, ‘no cost’ mortgages are subject to the following exceptions:
Per Diem interest (the interest incurred from the closing date to the first day of the following month) is excluded because it cannot be estimated when the exact closing date it will be. The lender doe not cover for tax escrows, homeowner’s insurance or transaction taxes if any.
Major considerations
(a) When selecting a lender for a traditional mortgage, borrowers typically ignore settlement costs, which they discover after they have applied for the mortgage and they receive estimates they are subject to change. This allows lenders to mark up their fees and those of third parties. On the contrary, when purchasing a ‘no cost’ loan, borrowers consider only the interest rate, which is the rate to cover the true costs of the mortgage. Therefore, ‘no cost’ mortgages can protect borrowers against being overcharged.
(b) If the borrower buys a ‘no-cost’ loan through a broker, the broker’s fee is an additional cost that will be covered by the rate. Therefore, lenders limit the rebates they offer for higher interest rates, thus limiting broker fees. Studies on brokered loans suggest that total settlement costs including broker fees are $1500 lower on ‘no-cost’ mortgages than on other mortgages. It is estimated that this $1,500 are lower broker fees.
(c) ‘No cost’ mortgages may carry prepayment penalties to discourage borrowers from refinancing. So, borrowers should check the rules to see if a lower rate for refinancing saves them money after all in case they are required to pay a penalty.
In conclusion, ‘no cost’ mortgages seem like a better deal for borrowers because they are easier to shop and simpler to understand. However, as they carry higher interest rates in the long run, borrowers need to investigate all factors before applying for a ‘no cost’ mortgage against a traditional mortgage. In most of the cases, borrowers end up paying more money as a trade off for saving on the upfront payments.
http://realestate.yahoo.com/calculators/no-cost_vs_traditional.html
Francisco
‘No-cost’ mortgages often seem like a great deal for the most part because they don’t carry the closing costs that are typically around 3 to 5 percent of the loan amount. However, the truth of the matter is that all mortgages carry costs. The difference is that a ‘no-cost’ mortgage converts the upfront costs to costs paid over time at a higher interest rate. This means the borrower saves money now, but ends us paying more money in the long run.
Example
To illustrate better how a ‘no cost’ mortgage works and how it differs from a traditional mortgage we assume that a borrower is looking for a $200,000 mortgage at a 30-year fixed rate.
Lender A offers a traditional mortgage at 6 percent with $2,200 fees (including lender fees $600, credit report $50, appraisal $300, title insurance $800, Reconveyance fee $75, recording fee $45, wire & courier fee $55, endorsement feel $75, title closing fee $125, document preparation $30, other fees $45).
Lender B offers a ‘no cost’ mortgage with a rate of 6.5 percent.
Monthly payments:
Traditional mortgage (6.00%): $1,211
‘No-Cost’ mortgage (6.50%): $1,276
In simple terms, this means that if the borrower buys a traditional mortgage, he would have to pay $2,200 more upfront, but monthly payments would be $65 lower ($1,211 rather than $1,276). If he buys a ‘no cost’ mortgage, there are no upfront costs, but monthly payments are $65 higher ($1,276 rather than $1,211).
By buying the ‘no cost’ mortgage to avoid the upfront fees it doesn’t mean the borrower saves money. After 3 years (36 months) of paying that extra $65, he would have exceeded the $2,200 he originally saved ($65 x 36 = $2,340). Eventually, he will pay a lot of money in the ‘no cost’ mortgage, unless he chooses to refinance in three years.
The example assumes that, all things being equal, the only difference between traditional mortgages and ‘no cost’ mortgages are the upfront costs. However, in reality, not all costs associated with closing are waived in a ‘no-cost’ mortgage. ‘No cost’ mortgages do not carry processing fees and the appraisal and credit report fees, but they carry government taxes, homeowner’s insurance and any funds required for escrow. Therefore, they are not cost-free.
In particular, ‘no cost’ mortgages are subject to the following exceptions:
Per Diem interest (the interest incurred from the closing date to the first day of the following month) is excluded because it cannot be estimated when the exact closing date it will be. The lender doe not cover for tax escrows, homeowner’s insurance or transaction taxes if any.
Major considerations
(a) When selecting a lender for a traditional mortgage, borrowers typically ignore settlement costs, which they discover after they have applied for the mortgage and they receive estimates they are subject to change. This allows lenders to mark up their fees and those of third parties. On the contrary, when purchasing a ‘no cost’ loan, borrowers consider only the interest rate, which is the rate to cover the true costs of the mortgage. Therefore, ‘no cost’ mortgages can protect borrowers against being overcharged.
(b) If the borrower buys a ‘no-cost’ loan through a broker, the broker’s fee is an additional cost that will be covered by the rate. Therefore, lenders limit the rebates they offer for higher interest rates, thus limiting broker fees. Studies on brokered loans suggest that total settlement costs including broker fees are $1500 lower on ‘no-cost’ mortgages than on other mortgages. It is estimated that this $1,500 are lower broker fees.
(c) ‘No cost’ mortgages may carry prepayment penalties to discourage borrowers from refinancing. So, borrowers should check the rules to see if a lower rate for refinancing saves them money after all in case they are required to pay a penalty.
In conclusion, ‘no cost’ mortgages seem like a better deal for borrowers because they are easier to shop and simpler to understand. However, as they carry higher interest rates in the long run, borrowers need to investigate all factors before applying for a ‘no cost’ mortgage against a traditional mortgage. In most of the cases, borrowers end up paying more money as a trade off for saving on the upfront payments.
http://realestate.yahoo.com/calculators/no-cost_vs_traditional.html
Francisco
