- The Truth About Zero Cost Loans

One of the most confusing areas for consumers in a mortgage loan transaction are closing costs. Here I'll explain the advantages and disadvantages of the highly advertised "zero cost" loans.

First and foremost, there is no such thing as a zero cost loan! Everyone knows there are costs associated with getting a mortgage loan; appraisal, credit reports, state taxes, county recording fees, title companies fees, lender fees, escrows, and more.

In a no lender fee or zero cost loan, the lender uses "negative" points to offset your costs. In the example below, by having the 8.00% rate, you can offset (or pay through interest rate) a large portion of your closing costs. Paying the higher rate makes it appear to you as if you have no, or reduced closing costs.

The general fixed rate loan "no cost" formula is that for every 1/8th percent increase in interest rate, you can usually eliminate 1/2 percent of the loan amount in cost. So on a $100,000 loan, by increasing the interest rate 1/8th, I can reduce $500 in closing costs. By increasing the rate 1/4 percent, I would reduce closing costs by $1,000. This DOES NOT apply to ARM (adjustable rate) loans.

No matter what anyone says, a zero cost, or no lender fee loan is NOT automatically a great deal. Although it may sound so much better than paying thousands in closing fees, you have to analyze each individual loan and client situation to determine the benefits. Many lenders speak highly of the "thousands of dollars" you save in fees. They never discuss the fact that you may spend significantly more in interest over the life of the loan than you ever saved in up-front closing costs! In the example below, you pay $64,474 MORE in interest to save $4,000 today!

	BEST	NORMAL	OK?	BAD??
Considerations on a $200,000 - 30 year fixed loan	Closing Costs Paid Out of Pocket	Closing Costs Added to Loan	No Lender Fee Loan	Full No Cost Loan
Loan Amount	$200,000	$204,000	$200,000	$200,000
Interest Rate	7.50%	7.50%	8.00%	8.75%
Principal & Interest Payment	$1,398	$1,426	$1,467	$1,573
Closing Cost Paid	$4,000 + Prepaids	$0.00 + Prepaids	$1,000 + Prepaids	$0.00
Interest Paid over 5 years	$75,182	$76,685	$80,235	$87,830
Interest Paid over 10 years	$143,443	$146,311	$153,597	$168,901
Interest Paid over 30 years	$305,475	$311,583	$330,353	$368,474

FACT: In a refinance loan, the vast majority of people roll the closing costs into the new loan.

A common misconception is that a zero cost loan is better than adding thousands of dollars in closing costs to the new loan. THIS IS NOT TRUE! Even if you were to only stay in the property 5 years, why have the higher payment when a few thousand dollars added to the loan principle is meaningless (especially in todays dramatically increasing home price market). Please call me, I'll run your personal numbers. Then you can decide if a zero cost loan is right for you.

I hope this article has helped you to understand the varied measures used to determine the advantages and disadvantages of zero cost loans. Each borrower is different, and the evaluations must be made on a case-by-case basis. As you can see, there are many factors to consider when looking at the available options. With us as your personal Mortgage Consultants, we will be able to answer all of your questions, outline the costs and benefits, and even give you a few new ones to consider! Of course, if a zero cost loan makes sense for your case, we will be happy to do one for you.