No
Cost Loans - Zero Cost Loans
No Cost or Zero Cost loans are mortgages where the bank or lender pays all of
your costs in return for you taking a higher interest rate and a higher payment.
Zero Cost Loans are just
negative point loans
where you take a high enough rate to cover all of the costs instead of only
part of the costs.
As with any type of loan, there is no hard and fast rule as to whether you should
do this or not. In this article, you will learn here how to tell if this might
be good for you, when it is not a good choice and the ways to tell if you are
paying too much for that zero cost loan.
There are many circumstances where it may make sense to take a zero cost loan,
but you need to consider all the consequences that come with taking a higher
interest rate.
No Cost Loans are appropriate for borrowers who:
are short on cash
can get a lower rate with no out of pocket expense
can shorten the length of their loan
know they will be in the loan a short time before selling or refinancing
again
The Short on Cash Borrower
The borrower who just doesn't have enough cash to pay the costs in addition
to the other things associated with the mortgage can benefit from a zero cost
loan.
A higher interest rate can end being a smaller amount to pay when it makes the
difference in how much of a downpayment that you have.
For instance, if a 20% down payment is $15,000 and closing costs are $3,000
and you are a borrower who only has $15,000, only putting down $12,000 on that
house would cause you to pay PMI and perhaps even a higher rate for not having
the whole 20% down.
A borrower in this situation can end up ahead of where they would be when they
have to pay costs.
When You can get a Lower Rate and a Lower Payment
When the interest rates are lower than you are paying now and you can lower
your payment without adding years to your mortgage, the zero cost loan can be
a good option for you.
Take this scenario. A borrower has two choices. They can refinance and save
$80 per month at the current lower interest rate and pay $2,000 of closing costs
or save $40 per month with no closing costs. Which makes more sense?
It will take 50 months for this borrower to recapture the $2,000 in this situation.
The borrower who has taken a lower rate and payments, with no costs, begins
to realize the savings immediately instead of waiting 5 years for the savings
start to kick in.
During the past few years, there have been quite a few borrowers who refinanced
more than once and paid the costs each time, ending up being a very expensive
proposition to keep refinancing. Many of these borrowers never recaptured the
costs of the first refinancing before they jumped in again.
And this is why you must be very careful paying too much for a loan that will
save you money when you can save without paying any costs. Of course, if you
keep the loan for more than 5 years you could be saving more in the long run,
but before you go chasing that "lowest rate" you need to ask yourself
the question of where you will be in 5 years.
Whenever it takes 5 years or longer to recapture the costs, consider not paying
those costs.
Remember that the "average borrower" keeps a mortgage loan just 5
years and unless you are absolutely sure that you will not refinance or sell
the home within the next 5 years, paying costs may not be the most prudent option
for you.
Shorten The Length of the Mortgage
Whenever you are in a position to lower your payments with a refinance, you
should always take a look at shortening the length of the loan.
Most refinances result in a borrower taking a step backwards and actually adding
years to the mortgage. Thanks to programs today that allow 25 year, 20 year,
15 year and 10 year mortgages, you often can takes years of payments off for
the same or little cost per month.
If you can do this with no costs in a zero cost loan, what a great opportunity
that you should not pass up.
Don't be so caught up in the lower payments game that it ends up costing more
money in the long run.
In the home or the Mortgage a Short Time
For a borrower who knows they will be in a loan for less than 5 years, they
should immediately consider the no cost loan option.
As shown above, and in the
negative points
article, short term mortgage borrowers should look for the lowest cost options
available to them.
Of course these borrowers are also looking at ARM's instead of fixed rates,
but often a higher interst rate on that ARM can literally save thousands of
dollars.
Always ask what the rate will cost you in points rather than what the rate for
a no cost loan is.
Be careful of How High an Interest Rate You Pay
Any discussion about no cost loans would not be complete without speaking of
the possibility of overpaying for that no cost loan. Because points are not
put into even numbers it actually may end up cheaper for you to pay a couple
hundred dollars of closing costs rather than no costs at all.
For instance, if a borrower has a $150,000 loan and $2000 in costs, the costs
are actually 1 and 1/3 points. Let's say that 1/4% higher interest rate would
cost you 1.25 points and 3/8% higher interest rate will cost you 1.75 points
as follows.
The rate for a "no-cost" loan is at the 3/8% higher interest rate.
First off, 1.75 points is equal to $2625 and $625 has been overpaid to get that
"no-cost " loan. The $625 is likely going to your mortgage professional
as a bonus!
At the lower interest rate, you do not have a no-cost loan, just a negative
point loan. The 1.25 points actually works out to $1,875 of costs paid for you
and you have to pay $125 for the mortgage.
Let's look at what asking for the no-cost loan has really cost you in this situation.
If a $150,000 mortgage is regularly at 6%, 1/4% higher would cost about $24
per month higher and 3/8% would cost about $36 a month higher, OK?
Not only have you left $625 on the table (or in your mortgage professional's
pocket) but you also are paying $12 a month more.
Saving the $12 per month pays you back for the $125 in just one year.
Summary
Zero Cost Loans or No Cost Loans can be of a great benefit for many borrowers,
but the bottom line is that it often is better to pay a little bit for the mortgage
than nothing at all.
The bank rates do not often come out evenly and getting all the costs paid for
you at closing will more often than not actually end up with you overpaying
for a loan.
