Shopping for a Mortgage: No Closing Cost Mortgage, Is it a Good Idea?

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So you are shopping for a mortgage and you want "No Point and No Fees." Sure, this sounds great on the surface but what are you giving up to make this happen? Here is how it works: To get a no cost mortgage you exchange a higher interest rate for the "no points or fees" option.

Question: "I want to get a new mortgage or refinance my mortgage for No Points and No Fees but I want to know if that is a good idea?"

The relationship between fees and interest rate is a commonly misunderstood. Loan prices move with financial markets and can change constantly. However, the way loans are priced stays the same.

A loan that generates no income is called a "par" loan. It's a loan offered at a given interest rate where the bank pays no money to the seller or broker of that loan. These loans are commonly referred to as the "going rate" for any given day. Of course, originating a loan is a complicated and expensive process and obviously no one would undertake that work for free. Selling a loan at a par rate will require income to be generated in other areas or in points and fees.

So if a mortgage seller wants to achieve a no points or fees loan, he or she would need to increase the interest rate enough to generate sufficient income to cover the fees and also produce a profit for the seller or broker of that loan.

Let's take a look at an example:

If we have a $100,000 loan and "par" for today is 6% with $3000 in fees and points. To achieve a no points mortgage we would need to raise the rate high enough that the bank would pay enough to cover the $3000.

"Yield Spread Premium" (YSP) is the term commonly used to describe the income generated on a mortgage transaction. The lender will pay the mortgage seller in "basis points" or percentages of the loan balance in exchange for the higher interest rate. This YSP money is what the seller would use to pay all the fees associated to the loan and to generate an income for the mortgage seller or broker.

So a loan balance of $100,000 and a "No Points and No Fees Mortgage" at 6.75% with the lender paying the seller 3% of the loan balance in exchange for the higher interest rate saving the homeowner $3000. Now it comes down to payment, is the increase of .75% worth the savings of $3000? Well it all comes down to math, what is the difference in monthly payment?

• Payment with points and fees at $100,000 loan and a 6% rate equals $599.55.
• Payment with No Points and No Fees at $100,000 loan and 6.75% rate equals $648.60.

Now this is the magic number: $49.05! This number is the difference in payment between the two options.

So is it worth it?

Focusing solely on the difference between the two mortgages we would divide the $3000 in fees into the savings of $49.05 to get 61. This is 61 months before we would make up all our $3000 we spent at the closing of the mortgage in fees and points. Refinance savings calculators can help you with this calculation if you do it a lot.

Answer: (Is it worth it?)

Only if you keep your home for more than 5 years would you want to pay the fees. If your time frame is shorter or you don't know how long you will keep the loan, opt for the loan with the lowest costs. Other factors that could influence this decision are :

• You are unable to qualify for the loan at the higher payment.
• The money allocated for fees could earn a higher rate of return on other investments.

There are many other ways to look at loans so be sure you work with a professional who can give you all the options just be sure you know how to pick the best loan for you.