You see it just about every day. A radio or TV ad offering a No Points / No Closing cost mortgage, AKA a “no-no” loan. Sounds great, right? Well, it may not be as good a deal as you think. First, to understand how a no points, no closing cost loan works, you have to understand a little bit about how a mortgage loan is priced. Mortgage lenders receive a wholesale rate sheet from a variety of secondary market investors where mortgage loans are bought and sold. The mortgage lender uses these rates sheets to set their daily pricing. Mortgage interest rates are very sensitive to happenings in the stock market. Therefore, mortgage pricing is subject to change up or down on a daily basis, sometimes multiple changes in one day. Most mortgage lenders advertise their best rate. Typically a lender’s best rate means that the borrower must pay all of their own closing costs. However, a mortgage lender may offer a borrower a higher interest rate in order to cover all or a portion of their closing costs. Offering a higher rate creates a premium. This premium can then be used to cover the borrower’s closing costs.
Consider this example:
First, let’s assume a loan amount of $100,000 for a rate & term refinance with closing costs of $2,900.
Today’s mortgage rate at XYZ Mortgage Company is 4.250% for a 30 year fixed. In this example the borrower would pay all closing costs.
Now, let’s say that XYZ Mortgage Company offers to pay all, or a portion of the borrower’s closing costs. Here’s how a lender determines what rate they would need to offer their borrower in order to pay closing costs.
From the information above we know that at a rate of 4.250% a borrower would need to pay all of their own closing costs. Now, let’s say that at a rate of 4.500% a premium of 1% is generated. To determine how much this 1% premium would cover in closing costs, simply multiply 1% X loan amount (1% X $100,000 = $1,000). So, in this example, if the borrower were to take the higher rate of 4.500%, the lender could cover $1,000 worth of the borrower’s closing costs. If the lender would like to pay more than $1,000 worth of closing costs, they would need to increase the interest rate accordingly.
IMPORTANT NOTE: The amount of premium a higher rate will generate may change from day to day depending on the market. In the previous example we see that a rate of 4.500% creates a premium of 1%. If pricing changes tomorrow, that rate of 4.500% may only generate .750% in premium… or if the market improves, it could create 1.250% in premium. Again, it depends on the market.
As the loan amount increases, so do the amount of the closing costs (and vice versa). Generally speaking, closing costs on a $100,000 loan are anywhere between $500 – $1,000 less than say a loan amount of $400,000.
On larger loan amounts, the dollar amount of the premium generated through a higher interest rate is greater. See illustration below:
Using the earlier example above let’s consider a loan amount for a rate & term refinance of $100,000. Assume the borrower chooses the higher rate of 4.500% that will generate a 1% ($1,000) premium to be used toward covering closing costs. At a loan amount of $100,000, the estimated closing costs are $2,900. After the 1% ($1,000) premium is applied, the closing costs now become $1,900. ($2,900 – $1,000).
Now let’s assume a loan amount of $400,000 with $4,000 in closing costs. Using the same interest rate scenario as above, we know that at a rate of 4.500% a 1% premium is generated. 1% of $400,000 = $4,000. The lender can pay ALL of the borrower’s closing costs in this example!
As you can see, the premium generated through a higher rate of 4.500% created a 1% premium for both loan amounts of $100,000 and $400,000 used in the examples above. However, at the lower loan amount of $100,000, the lender could only pay a portion of the closing costs.
A mortgage lender can offer to pay all or a portion of your closing costs through premium pricing of your interest rate. Your final interest rate depends on your loan amount and the amount of your closing costs. Remember, the interest rate and the premium that can potentially be generated through a higher rate, can fluctuate on a daily basis. Therefore it is important to request a quote on the same date, and as close to the same time when comparing loan programs among lenders.
So, does it make sense to take a loan with “No Points and No Closing Costs”? There’s really not an easy answer to that question. There are many variables to consider and every borrower has different circumstances. For example, do you have enough equity to finance the closing costs in to the new loan? If so, that may be a better option than taking a higher rate to cover your closing costs since the cost of a higher rate over the life of your loan may far exceed your total cost if you were to finance in to your new loan.
The best approach to determining if refinancing is right for you is to consult with a seasoned mortgage professional. For over 15 years I have been providing my clients with cost effective solutions to refinancing. I take a consultative approach where I will evaluate your current situation and determine the best course of action. With today’s mortgage rates at historic lows, there has never been a better time to refinance. Call today for a free consultation. It could save you thousands!
