No-closing-cost mortgage: How it works and how to decide if it’s right for you
Key takeaways
- Many lenders offer no-closing-cost mortgages, meaning you don't need to pay the closing costs upfront when you buy a new home.
- Instead, closing costs are rolled into the loan balance or compensated for in the form of a higher interest rate.
- On the plus side, no-closing cost mortgages mean less immediate outlay. On the downside, these loans tend to cost more over their lifetimes.
Every home loan and refinance comes with closing costs, which can be a hurdle if you’re short on the cash needed to seal the deal. That’s where a no-closing-cost mortgage comes in. Instead of paying the closing costs in a lump sum when you buy a home, the various fees are rolled into the loan balance or padded into your mortgage interest rate.
Sound like a good deal? It can be, but only after you weigh the pros and cons. Here’s how no-closing-cost mortgages work and how to decide if one is right for you.
What is a no-closing-cost mortgage?
The name “no-closing-cost mortgage” is a bit of a misnomer. Closing costs don’t magically disappear. It’s just that you’re not paying them all at once, in cash, on closing day.
“You’ll still be responsible for these fees,” says Chuck Meier, senior vice president and mortgage sales director for St. Paul, Minnesota-headquartered Sunrise Banks. “The only difference is that, under a no-closing-cost mortgage, your lender will either add those fees onto your principal balance or charge you a higher interest rate on the loan to cover those closing costs.”
How no-closing-cost mortgages work
Virtually every homebuyer incurs closing costs, which typically include fees for expenses such as the home inspection, home appraisal, title fees, municipality deed or mortgage registration taxes and recording fees. Closing costs might also include the expenses associated with underwriting, processing and originating the mortgage itself.
When getting a no-closing-cost mortgage, you don’t have to pay these fees upfront, but you’ll still have to pay them over the loan’s lifetime. Lenders usually offer a couple of different options, which include:
- Rolling costs into your loan balance: Let’s assume you’re seeking to borrow $250,000, and your closing costs total $8,000. That means your mortgage principal — the amount you’ll actually borrow — is $258,000.
- Paying a higher interest rate on your loan: Say you qualified for a 30-year mortgage at a fixed rate of 6 percent. The lender might offer to up your interest rate to 6.5 percent (50 basis points higher) to cover your closing costs.
“With either of these choices, you will not pay the closing costs out of your bank account. But you will still pay for these closing costs over the life of your loan,” says Matthew Posey, a residential mortgage loan originator with Axia Home Loans in Austin, Texas.
Pros and cons of a no-closing-cost mortgage
When making your decision, carefully weigh the benefits and drawbacks of choosing a zero-closing-cost mortgage.
Pros of no-closing-cost mortgages
There are some key advantages to consider when deciding whether a no-closing-cost loan is right for you:
- Less cash to close: “The pros include not having to pay those additional fees with liquid funds,” says Daniel Hill, CFP and president of Hill Wealth Strategies in Richmond, Virginia. You won’t need to drain savings accounts or sell stocks to come up with as much money upfront, incurring the risk of becoming house poor.
- More liquidity down the road: You can use the money you didn’t spend on closing costs for an emergency fund, a home-maintenance fund, general savings or even investments.
- Easy payments: “There’s also the convenience of having your closing costs divided among your mortgage payments over the life of your loan,” says Hill.
Cons of no-closing-cost mortgages
Before applying for a no-closing-cost mortgage, consider these drawbacks:
- Fewer options: Almost every mortgage lender offers traditional loans with closing costs, but not all lenders have no-closing-cost mortgages. You’ll have fewer options to work with, which can make it hard to shop around for a good deal.
- Less home equity: Because you’re financing a larger amount of the home purchase, you start out with less of an outright ownership stake in your home.
- Bigger interest bite: “You’ll probably be getting a less-attractive loan than you otherwise would if you were willing or able to pay for closing costs,” says Rajeh Saadeh, a Somerville, New Jersey-based real estate attorney. “You’ll likely pay more interest over your loan’s term, depending on how long you stick with that loan.”
Case in point: Using the previous scenario, if you borrow $400,000 over 30 years at a 7 percent interest rate and pay your $12,000 closing costs out of pocket on closing day, the total cost of your mortgage — principal and interest alone — would be $958,216 by the term’s end. However, if you choose to roll your closing costs into your mortgage, now with its higher interest rate (going from 7 to 7.5 percent), your total loan costs over 30 years would be $1,007,716.
In other words, you will have paid $49,500 extra just in interest — a lot more than shelling out the original closing cost lump sum of $12,000.
No-closing-cost mortgage vs. traditional mortgage
No-closing-cost mortgages are appealing because they let you buy a home without needing to shell out thousands of extra dollars — at a time when you’re probably feeling strapped by plenty of other expenses (the down payment and moving costs). However, it’s important to think about the long term. You’ll be paying for the higher cost of a zero-closing-cost mortgage for years to come — 15, 30 or whatever your mortgage term is.
Imagine you plan to buy a $500,000 home with a 20 percent down payment. That means you’ll need to borrow $400,000 to finance the purchase. You get two quotes for 30-year loans, a traditional mortgage at 7 percent interest and a no-closing-cost loan at 7.5 percent.
Let’s say closing costs on the traditional mortgage come to 3 percent of the principal — $12,000. Your monthly payment on the traditional loan would be $2,661; the payment for the no-closing-cost loan would be $2,797.
Just $136 more a month for the no-closing-cost option doesn’t sound like much. But look how it adds up over time, according to Bankrate’s loan amortization calculator.
| Years Elapsed | Total Paid Traditional Mortgage* | Remaining Balance Traditional Mortgage | Total Paid No-Closing-Cost Mortgage | Remaining Balance No-Closing-Cost Mortgage |
|---|---|---|---|---|
| *includes principal, interest and closing costs paid upfront | ||||
| 1 | $43,932 | $395,936.76 | $33,564 | $396,312.66 |
| 5 | $171,660 | $376,526.36 | $167,820 | $378,469.75 |
| 10 | $331,320 | $343,249.53 | $335,640 | $347,179.95 |
| 20 | $650,640 | $229,200.31 | $671,280 | $235,620.59 |
| 30 | $969,970 | $0 | $1,006,920 | $0 |
With the no-closing-cost mortgage, you’ll have paid less overall until partway through the 10th year of your loan, though you’ll also have accrued slightly less home equity. But then, the accumulated cost (augmented by the additional interest) begins to kick in. By the end of the mortgage terms, the overall cost of the traditional loan comes to nearly $37,000 less than that of its no-closing-cost counterpart.
How to decide if a no-closing-cost mortgage is right for you
No-closing-cost home mortgages have advantages and disadvantages, and not everyone is a good candidate for one. It’s generally best for those buying a starter or temporary home that they’ll leave within a decade or so (as opposed to buying a forever home). Or, of course, it can work well for those who are absolutely strapped for cash, making a five-figure upfront payment a real problem.
Before committing to a zero-closing-cost mortgage, consider how long you plan to stay in the home and how much cash you have on hand that you’re willing to part with upfront.
How to find no-closing-cost mortgages
So, who offers no-closing-cost mortgages? Most lenders do. If you decide to pursue this route, take the time to shop around and find the right lender for your needs. As you compare lenders, make sure you understand all aspects of the loan offer, including closing costs and any no-closing-cost options. A mortgage calculator can help you crunch the numbers to estimate and compare your total costs with both a traditional and a no-closing-cost mortgage.
If you’re working with a mortgage broker, they might even be able to help you find a low-fee lender, or one who just rolls the closing costs into the principal, but doesn’t hike the interest rate, on its no-closing-cost mortgages. (You’ll still pay more in interest because the mortgage principal is bigger, but the bite won’t be as bad).
Other ways to get a low-closing-cost mortgage
Getting a mortgage with no closing costs isn’t the only way to reduce the fees you pay at closing. You can also try negotiating with your lender and asking for a discount on some of the fees they’re charging you. Lenders might be unable to reduce all the closing fees, but some may be negotiable.
You can also ask the seller to cover some of the closing costs. This tactic works best in a buyer’s market when sellers are having difficulty closing a deal. In a seller’s market where competition for homes is steep, it can be more difficult to successfully make this request.
Frequently asked questions on no-closing cost mortgages
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Yes, many lenders will let you roll your closing costs into a home loan. This means you get a loan for the amount you owe on the property and the closing costs. This is called a no-closing-cost mortgage or a zero-closing-cost mortgage.
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A no-closing-cost mortgage may be a good idea for some people, but it’s not right for everyone. The right move depends on your financial situation and your plans for the home. A no-closing-cost mortgage costs more in interest over time. However, if you plan to stay in the home for only a few years, it may be worth it.
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You can refinance a mortgage without paying closing costs upfront. This is called a no-closing-cost refinance. In this type of refinance, any closing costs are rolled into the new loan balance.
