If you’re looking to buy a new home, you probably need a mortgage to finance it. And it pays to shop around with mortgage lenders to see which one comes back with the best deal. But it’s not just interest rates you should look at when comparing offers — also keep closing costs in mind.
Closing costs are the various fees you pay to finalize a mortgage, and those fees vary from lender to lender. In 2020, closing costs averaged $5,749 nationally, including prepaid property taxes (property taxes are often paid quarterly, so when you buy a home, you generally prepay to cover your bill through the end of the quarter of your home purchase).
Some lenders, however, don’t charge any closing costs on a mortgage. And as a borrower, you may be inclined to opt for a loan without those fees. But is a no-cost mortgage a smart idea? Here’s why it may not be.
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There’s always a catch
Most things in life aren’t free, and that extends to mortgage closing costs. Now this doesn’t mean lenders routinely advertise no-cost mortgages, then stick you with fees at the end. You may really get out of paying closing costs on a loan. But avoiding closing costs doesn’t mean you automatically get a better deal.
A no-cost mortgage is almost guaranteed to come with a higher interest rate. You’ll need to crunch some numbers to see what your loan will really cost you.
Say a lender charges you $5,000 in closing costs and an interest rate of 3.2% on a 30-year fixed loan of $200,000. That means you’ll pay $865 a month for principal and interest on that loan, and a total of $111,534 in interest over your entire repayment period.
Now, let’s compare that to a no-cost mortgage that waives closing fees but charges you 3.5% interest. In that case, your monthly principal and interest payments will be $899, which isn’t all that much higher than the $865 you’d pay in our first scenario. But when we total up interest paid over the life of that loan, it comes to $123,472. That’s a difference of $11,938. When we compare that to the $5,000 in avoided closing costs, we see that in the long run, it’s not the better deal. That no-cost option winds up costing about $7,000 more all-in.
This isn’t to say that a no-cost mortgage is never a good idea. You may find a lender willing to waive fees and come up with a competitive interest rate. But lenders need to make money one way or another, so don’t be fooled into thinking a no-cost mortgage is always your best bet. At the end of the day, you wind up paying those fees in one form or another.
Read More: Is a No-Cost Mortgage Too Good to Be True?