You can pay me now or you can pay me later!

by Michael Eastham, CPA CRMS

Have you ever seen an advertisement or received a mailer stating that you can refinance your home with absolutely “No Closing Costs”? Have you thought that this sounds too good to be true, but because it piqued your interest, you just had to call the mortgage company to inquire? Allow me to save you the time and aggravation by simply telling you this: Nothing is free in this world and there are always closing costs paid by someone on every mortgage transaction. So you can pay now or you can pay later--it is completely up to you.

What do I mean by that? Well, let me start by offering you a little tutorial about how mortgage companies are compensated. Mortgage brokers like us receive payment in various ways:

1. directly from the homeowner
2. directly from the institution that we ultimately sell the loan to
3. or a combination of the two

When a mortgage broker is paid directly from the homeowner, it is very straightforward. It will be identified on the HUD-1 closing statement as “Origination Fee,” “Mortgage Broker Fee,” or something similar. However, when paid by the institution that purchases the loan, it is different. Compensation is then based on the interest rate that is charged to the homeowner.

This is where it gets interesting. Mortgage brokers have the flexibility to increase or decrease the interest rate, depending on the situation. If they decrease the rate, they will earn a lower fee from the lending institution. Conversely, if they increase the rate, the lending institution will pay more of a fee because of the greater rate of return on that loan. In addition to managing the fee received, mortgage brokers are able to return some of, or the entire fee to the homeowner in the form of a credit in the transaction. This is how a mortgage broker can advertise “no closing costs.” If a broker receives more of a fee than would normally be charged on a particular transaction, then rebates part of the fee to the homeowner, the closing costs to the homeowner, in effect, have been reduced or even eliminated. However, this does not change the fact that closing costs existed. They were simply paid by the mortgage broker.

Now, you may be wondering, how does this affect you, the borrower? Let’s look at an example. Using a $250,000 loan amount, assume the closing costs are $4,000. If you pay the closing costs yourself and the interest rate on a 30-year fixed rate mortgage is 7%, your payment will be about $1,663 per month. If you prefer the “no closing costs” option, your rate may be 7.375%. This will increase your monthly payment to about $1,727 per month. The difference of $64 per month equates to $23,040 over the full term of the loan. The breakeven point in terms of the difference in payment is about five years.  That means if you plan to keep the mortgage more than five years, it may make more sense to pay for the closing costs yourself because the increase in payment will be more than the closing costs. Alternatively, if you have a better use for the payment differential, it may make sense to pay the costs out of pocket or simply roll them into the loan.

The flexibility that exists here is morally neutral. In fact, it gives homeowners a lot of options if they are working with a professional who is able to help them develop a sound plan. It is very similar to making a decision about paying discount points to lower the interest rate. You need to analyze your goals and see if the benefit outweighs the cost.

The bottom line is that “No Closing Costs” does not mean it is free. There will always be closing costs associated with a new mortgage.  How they get paid and by whom, depends on your personal goals and the plan developed by you and your mortgage strategist, to accomplish your goals.