No Cost Home Loans – Is There Really a Free Lunch?

No Cost Home Loans – Is There Really a Free Lunch?

In this changing market place, many of us have seen lenders advertise the “no cost” loans. This sounds really good but what is a no cost loan? And what are the benefits of this kind of loan, if there is any?

First let me explain that the term of no cost home loan is used in the refinancing market consequently usually seen as the “NO COST REFINANCE LOAN”. It can be used in a buy but would take a sharp loan officer to put it together. Anyway back to the refinance it is a way that you can roll all the cost of the loan into the loan without increasing your loan balance. Say you are paying off a $199,999.99 loan you would take out a new loan for $200,000.00 (FNMA, FHLMC, GNMA requirements to round off) and you would not lose any equity in your character that you have now.

The assistance here would be if your LTV (loan to value) is close to say requiring (80.01% or above) or not requiring (80% or below) Private Mortgage Insurance, the better way to go is to take the no cost loan. Now the kicker is that there is really no free lunch and you are going to pay a higher interest rate. But wait, no all is bad here. You got out of the PMI requirement, so you have a lower payment than you would if had to pay an insurance premium in addition to your principal and interest payment, and you have maintained your equity.

If it were really a free lunch it would allow you to get the same market rate that you see advertised to others with good credit and 20% equity. If the Lender was in the business of doing everything for free and had no bills to pay, that would happen. But enough of the fairytale dreams and back to reality. We all know that they have to make money, so they can be there the next time you need a loan. So how does that happen if you haven’t paid any closing costs? Who paid for the title, appraisal, credit report, tax certificate, underwriting fees and so on if you didn’t? Well you did. The lender charged you an increased interest rate so there is enough money to cover those fees.

Here is an example: you take out a $200,000 loan. If you were not doing a no cost loan you would be offered a loan at the interest rate of say 5.125% with 1 point. (a point is 1% of the loan amount) and you would pay the closing fees of $3,000 and the point to equal $2000 Which would be a total of $5000 cost to you. Now the no cost loan would be offered to you at the rate of 5.875%. The same loan exactly except the Lender who nevertheless needs $5000 to close the loan will get it from the investor (where the lenders get their money) who is offering a 2.375% discount on that rate which would be $4,750, so the lender gets to pocket an little additional for their trouble. Sometimes they already put in a little to make the deal work. So you can see there really is no free lunch.

Now this is different from a “no out of pocket” loan because they just lend you $205,000 and pay everyone out of the loan proceeds.

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