Focusing only on your mortgage rate distracts you from the true cost of the loan – and that can be a costly mistake.
That’s because the lowest interest rate doesn’t always translate to the best loan deal.
All borrowers must pay closing costs usually between 3% and 6% of the loan. These fees can make or break the deal you think you’ll get on the interest rate.
The best deal depends on how long you keep your loan. A low mortgage rate looks attractive when calculating savings over 30 years. But the reality is that the number of borrowers who hold onto a loan for 30 years is “virtually zero,” says Laurie Goodman, former vice president of housing finance policy at the Urban Institute, a nonprofit think tank. non-profit.
One option often overlooked by borrowers is a no-fee loan. That means accepting a higher interest rate in exchange for no closing costs, and that can often leave you with more money in your pocket. By saving on initial closing costs, cash is freed up to be spent on other financial goals, like investing for financial independence or paying off debt.
Mortgage rates have reached pre-pandemic levels and house prices continue to hit record highs. This makes no-fee loans particularly attractive right now, as they can help reduce upfront costs – keeping more money in your pocket or more money to use for a higher drop. Payment.
Here’s what you need to know about no-fee loans.
How a higher mortgage rate can save you money
When presented with a no-fee loan or a low-rate loan with closing costs, it can be hard to tell which is right for you. At first glance, an interest rate seems to be the only saving factor in real estate financing.
Here’s how the two loan types compare on a $300,000 30-year loan:
|Refundable closing costs||Interest rate||Monthly payment||Total interest and fees|
|Ready to (Low rate + closing costs)||$9,000||3.9%||$1,415||$218,400|
|Loan B (Free loan)||$0||4.3%||$1,482||$234,459|
In this example above, Loan A will save the borrower $67 per month and $16,000 in total interest by choosing Loan A over Loan B. But that’s only if they keep that loan for 30 years. The savings in this example are calculated over the full 30 years of the loan. Focusing solely on the interest rate prevents potential borrowers from noticing another important number: Loan A’s $9,000 reimbursable closing costs.
With Loan B, a no-cost mortgage, the lender covers the cost of the loan with lender credits and the borrower accepts a higher rate. The borrower has $9,000 cash left in their pocket, which they could invest (and then earn compound interest), use to cover move-in costs (and thus avoid high APR credit card balances) , or set aside in savings or an emergency fund.
Close the gap
Rising housing rates and prices are making it increasingly difficult for potential buyers to access property. According to a 2022 analysis by the National Association of Realtors and Realtor.com, black Americans are particularly affected. The study cites that about half of all homes currently listed are affordable for households with a family income of at least $100,000. Yet only 20% of black households have incomes above $100,000, compared to 35% of white households. For those struggling to access home ownership due to a lack of down payment and savings on closing costs, a no-fee loan could work in your favor.
Many borrowers won’t keep a loan as long as they think they will
The mortgage interest rate alone doesn’t tell the whole story, says Gordon Miller, president of North Carolina-based mortgage broker Miller Lending Group. Especially since borrowers can pay to get the rate they want, he said. When you choose to pay closing costs up front to keep your rate as low as possible, “you’re paying today for a benefit you’ll never receive,” says Miller.
A typical borrower keeps a loan for less than 5 years, according to a 2016 study published in the Journal of Financial Economics. After evaluating more than 300,000 home loans in the study, the researchers found that “borrowers overestimate how long they will stay with the mortgage.”
With that in mind, instead of looking at how the loan plays out over 30 years, let’s look at what Loan A and Loan B (above) would cost you in interest earlier in the life of the mortgage.
Here’s how the two loan types compare on a $300,000 30-year loan over three, five, 10, 15, 20, and 30 years:
*Total cost exceeded:
|3 years||5 years||10 years||15 years old||20 years||30 years|
|Loan A (reduced rate + closing costs)||$59,940||$93,900||$178,800||$263,700||$348,600||$518,400|
|Loan B (higher rate + no closing costs)||$53,445||$89,076||$178,153||$267,229||$356,306||$534,459|
What this table shows is that loan A does not become a clear winner until the 15th year of the loan. Holding the B loan from year 1 to year 10 is actually cheaper overall, even with the highest rate – if you cancel the mortgage (refinance, pay off or move) before year 10 This is because the closing costs associated with Loan A are time consuming. time to actualize the savings.
The big question to ask when choosing a home loan is, how long do you plan to stay with this loan? If you’re sure a refinance or move will be in less than 10 years, a no-fee loan might be a better financial fit.
No-fee loans are easier to understand
When you eliminate your closing costs with lender credits, it’s easier to understand the terms of the loan and compare it to other no-fee loan offers. That’s because you only have to look at one number – the interest rate. You also won’t have to factor in closing costs and whether or not you’ll break even before your next refinance.
“Loans with simpler terms are cheaper. Borrowers who use “no-fee” loans and can therefore shop on the interest rate alone pay $1,200 less,” according to an Urban Institute study of FHA loans.
Lenders have an incentive to keep costs low when you don’t pay fees. “There’s no reason for them to pad things out because it’s coming out of their pocket,” Andrew Pizor, an attorney at the National Consumer Law Center in Washington, DC, told NextAdvisor.
There are two types of mortgage loans, commonly referred to as no-cost loans:
- The lender gives you credit to cover your closing costs in exchange for a higher rate.
- Closing costs are added to the loan balance.
When you request a free mortgage quote, make sure you know what options are available to you.
No-fee loans can give you more options with your money
When you don’t have to pay closing costs on a mortgage, it increases your financial flexibility. Here are other options for the money that would have gone to closing costs.
With the extra money available, you can work towards all kinds of goals. Imagine investing $9,000 in a low-fee index fund with an average annual return of 7%. A compound interest calculator shows that an investment of $9,000, without making additional contributions, would earn nearly $3,000 in interest over five years. That means your $9,000 could grow to $12,016 over the same length of time most homebuyers stay in their homes (five years). If you kept the $9,000 initially invested for 25 years, you would have $38,174.
Pay more towards loan principal
If your goal is to pay off your mortgage as quickly as possible, you can take the money that would have been spent on closing costs and instead use it to pay off your loan balance.
You can do this in two ways: Make additional payments toward principal each month. Or put the money intended for closing costs toward a larger down payment.
Having an emergency fund can be a lifeline for any unexpected hardship: loss of income, home repairs, medical bills, or car trouble, to name a few. Using a no-cost mortgage allows borrowers to conserve funds that would have gone towards closing costs and remain liquid in the event of a financial emergency.
How to Choose the Best Mortgage for Your Situation
Landing on a final mortgage offer depends on each borrower’s personal situation and financial goals.
To help you understand how to find the best home loan for you, whether you’re looking to refinance or buy, you can compare lenders’ offers using this Home Loan Comparison Calculator. You can enter the loan amount, rate, fees, and term for each offer and see a real side-by-side comparison. This comparison tool will show you the cost of each loan over time to help you decide which loan is right for you.
Real estate loan comparator
Compare your payment options side by side to see which one is right for you and your financial situation.
Find the mortgage that’s right for you by comparing the cost of multiple loans over time.
Why shopping is important
Whichever mortgage you choose, getting quotes from multiple mortgage lenders is key to finding the best deal for you.
The amount your interest rate will increase when you receive credit from the lender is not a fixed percentage. “You really have to look at how much higher your interest rate is going to be, which is going to vary from time to time. It’s not going to be a constant number,” Goodman says. Calculations for your specific loan options may be different from the examples above, making it important to run the number on your own using a home loan comparison tool.
According to research by Freddie Mac, getting multiple loan quotes could save you an average of $1,500 to $3,000 over the life of the loan.