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Many homebuyers -- first-time buyers in particular -- are surprised to learn that the process of getting a mortgage isn't free. Rather, lenders generally charge closing costs to finalize a home loan, and those costs can vary from lender to lender.
Closing costs are meant to cover expenses like title searches (to make sure your seller has the full rights to the home you're buying), recording fees, and appraisal fees. Though each lender sets its own fees, you can generally expect closing costs to amount to 2% to 5% of your loan amount. This means that if you're borrowing $200,000 to buy a home, expect to spend between $4,000 and $10,000 after all's said and done.
Some lenders, however, may offer you the option to sign a no-cost mortgage. In that scenario, you'll avoid upfront closing costs. But is that an offer worth pursuing, or one that's too good to be true?
The truth about no-cost mortgage closings
When a lender states that you're eligible for a no-cost mortgage, that's legitimate. You may, in fact, be able to avoid closing costs at the time you finalize your mortgage if that's the deal a given lender is willing to offer you.
But one thing you should know is that in these scenarios, a lender will generally charge you a higher interest rate on your mortgage to compensate. To see if a no-cost mortgage makes sense, you'll need to do some number-crunching.
Say you're looking to borrow $200,000. One lender offers you an interest rate on a 30-year fixed loan of 2.8% along with $5,000 in closing costs. Another lender offers you an interest of 3.05% on a loan with the same 30-year term, only no closing costs.
Your monthly mortgage payment in the first scenario will be $821 for principal and interest on your loan. In the second scenario, it will be $848, or $27 extra per month. When you factor in the $5,000 in closing costs you'll pay in the first scenario, you'll break even from paying that extra $27 a month after 185 months. But with a 30-year loan term, you're looking at a total of 360 payments, which means that over the life of your mortgage, you'll actually end up paying more for the loan without closing costs.
It's for this reason that no-cost mortgages aren't always the great deal they seem to be. While they sometimes make sense, remember that mortgage lenders generally don't give things away for free, and what you save on those upfront fees, you'll fork over in the form of higher monthly payments.
Now, you may be thinking that with a no-cost mortgage, you'll at least get the benefit of not having to write out a multi-thousand-dollar check at closing. But here's the thing -- generally, lenders will give you the option to roll your closing costs into your mortgage so you don't pay them up front anyway, thereby eliminating that worry.
In the course of applying for a mortgage, you may get a bunch of different offers -- some with higher closing costs than others, and some with no closing costs at all. Your best bet is to shop around and gather a number of offers so you can compare your choices before making your decision. Having options will help you reap the most savings in the end.