Closing Costs vs. No Closing Costs

Read Part 1 - What Fees Are Included In Closing Costs? Can You Avoid Them?

As we already discussed in the Part 1, closing costs can not be avoided, and customer always pays closing costs. There are no such programs as “No Closing Cost, No Points”. The correct name is the hidden closing costs. You should consider with your broker what is the best way to pay your closing costs when refinancing or purchasing a property.

You can choose the following options:

1)   Closing costs can be paid out of your pocket. Advantages: Lower interest rate and monthly payments; lower debt-to income ratio; as a result, it is easier to obtain financing. We recommend this option for customers who are planning to keep a property for a long run, and when interest rates are low. Disadvantages: This could not be attractive to borrowers who can earn high returns on their free cash, or those who don’t have enough free cash. Usually, full closing costs are around 3%-6% of your loan amount, besides down payment and reserves required by a lender. Owners who are planning to refinance or sell within a few years shouldn’t pay full closing costs, since they wouldn’t hold their original loans long enough to recoup their up-front costs.2)  Closing costs can be added to your loan amount when refinancing a property. Advantages: You need less money for refinancing. Disadvantages:  Financing closing costs can be very costly. The larger loan increases the cost of the mortgage.  For example, suppose financing $9,000 in closing costs on a $300,000 (80% LTV) will increase Loan-to Value (>80% LTV). As the result: you will pay higher rate because of LTV adjustment, higher monthly payments because of higher rate, higher loan amount, and PMI (Private Mortgage Insurance). Also, your debt-to-income ratio will increase, and it can be a bad choice if you don’t have enough income.

3) Closing costs can be covered by seller’s concession when purchasing a property. When you negotiate the purchase price, you can ask a seller to cover your closing costs instead of lowering the price.  it is a good idea, especially if you are purchasing and only have a designated amount of money to put toward the down payment and other expenses.

 4)  Closing costs can be covered by the higher interest rate – hidden costs – or as advertised “no closing costs”. Lender will increase your initial rate to cover your closing costs fully or partially.
Close to Par Rate + Markup (add on to the rate) = Final Rate resulting in YSP (yield spread premium) which covers closing costs. 
Advantages: don’t need to bring free cash for closing; your balance will not be increased. This option can be the right choice if you are going to keep your property for a short period of time (1-3 years); or if interest rates go down, and you are planning to refinance again and again on the way down. When interest rates are high, paying full closing costs doesn’t make sense because borrowers are very likely to refinance after rates dropped. Disadvantages: your final rate can be much higher than your initial rate; your monthly payments will be higher, the overall interest paid for the life of mortgage will increase substantially.

5)  Combination of the above.

With a variety of different closing costs option, it is important to choose the one that will best suit your needs and save you money on a long run. Be careful with no closing costs option. Ask your broker to calculate different options for you.