Matthew Tillman 
There are no free lunches!
Rarely can you listen to the radio without hearing a commercial offering mortgage loans with no closing costs. The tagline is “It’s the biggest no-brainer in the history of Earth.” Sound too good to be true? Well, it is. There are no free lunches. Who works for free? Certainly not the appraiser, title company, underwriter, closing attorney and most definitely not the loan officer. Each party performs an integral part of the process and should be compensated for their time and efforts. So, how can a lender make the claim “… no closing costs. We don’t roll them into the cost of the loan, we pay them…”
Why would the lender agree to work for free AND pay your closing costs? The answer is simple: they DON’T! The borrower always pays the closing costs. The mortgage process is confusing enough without a game of mirrors or playing some shell game.
Three options are available to the borrower to cover the costs:
- Write a check at the closing table (OUCH!)
- Increase the loan amount by an amount equal to cover the costs or
- Agree to an above market interest rate
Lender funded loans are not necessarily a bad thing and play an important role in the mortgage industry. If interest rates drop enough so that a “lender funded” loan is possible, it is worth exploring as an option. In years past, the rule of thumb was a drop of at least two percentage points on the new loan was necessary to justify the costs of refinancing. The reasoning was that the “break even” point of the costs vs the monthly savings could be reached quickly enough to make it financially feasible. For instance, if a borrower currently has a 30 year fixed rate of 6.750% and the interest rate available in the market place is 4.750% then the borrower could realize a substantial monthly savings. The question to answer is how best to cover the costs associated.
In the case of the “lender funded” loan, a drop of 2.000% is not always required. Lets assume the interest rate available in the market place for a 30 year fixed is 4.750%. The borrower has a loan balance of $250,000 with a rate of 6.000%. This doesn’t meet the threshold of a two percent drop to justify the costs. However, if the lender were to increase the rate offered on the loan to 5.250% or 5.500% and the borrower had no “out of pocket” costs AND did not add to their loan balance, would it make sense? Lets do the math.
| Current | Option #1 | Option #2 | |
| Loan Amount | $250,000 | $250,000 | $250,000 |
| Interest Rate | 6.000% | 4.750% | 5.500% |
| Term | 30 years | 30 years | 30 years |
| P & I Payment | $1,498.88 | $1,304.12 | $1,419.47 |
| Costs | N/A | $5000.00 | $0 |
| Monthly Savings | N/A | $194.76 | $79.41 |
| Breakeven | N/A | 26 months | 0 months |
In the above example, the borrower must remain in the property for more than two years (26 months) before the costs associated with the new loan are realized. Whereas the lender funded loan would reduce the monthly payment without ANY break even point. However, over 30 years the borrower would to pay an additional $41,526 in additional interest because of the higher interest rate! ($194.76 - $79.41 = $115.35 X 30 years = $41,526). Conversely, if the borrower opts to pay the closing costs, once the break even point is reached the savings are substantial! (360 months – 26 months = 334 X $115.35 = $38,526.90)
Each scenario is different and every borrower has their own unique needs. The borrowers overall goal should first be determined and then be presented with 2 or 3 loan scenarios to consider. Perhaps a reduction in the loan term from 30 to 15 years can be achieved with little or no change in the monthly payment. Either way, call around, get a few quotes, compare costs and be sure to ask lots of questions.
Much of the mortgage process is confusing. Find a mortgage professional you can trust. And remember, if it sounds too good to be true, it is!
