When you apply for a mortgage or refinance an existing mortgage, you want to secure the lowest interest rate possible. Any opportunity a borrower can exploit to shave dollars off the cost is a big win.
This explains the allure of no-fee mortgages. These home loans and their promise of doing away with pesky fees always sound appealing—a lack of lender fees or closing costs is sweet music to a borrower's ears.
However, they come with their own set of pros and cons.
No-fee mortgages have experienced a renaissance given the current economic climate, according to Ralph DiBugnara, president of Home Qualified. "No-fee programs are popular among those looking to refinance ... [and] first-time home buyers [have] also increased as far as interest" goes.
Be prepared for a higher interest rate
But nothing is truly free, and this maxim applies to no-fee mortgages as well. They almost always carry a higher interest rate.
“Over time, paying more interest will be significantly more expensive than paying fees upfront,” says DiBugnara. “If no-cost is the offer, the first question that should be asked is, ‘What is my rate if I pay the fees?’”
Randall Yates, CEO of The Lenders Network, breaks down the math.
“Closing costs are typically 2% to 5% of the loan amount,” he explains. “On a $200,000 loan, you can expect to pay approximately $7,500 in lender fees. Let's say the interest rate is 4%, and a no-fee mortgage has a rate of 4.5%. [By securing a regular loan], you will save over $13,000 over the course of the loan.”
So while you'll have saved $7,500 in the short term, over the long term you'll wind up paying more due to a higher interest rate. Weigh it out with your financial situation.
Consider the life of the loan
And before you start calculating the money that you think you might save with a no-fee mortgage, consider your long-term financial strategy.
“No-fee mortgage options should only be used when a short-term loan is absolutely necessary. I don’t think it’s a good strategy for coping with COVID-19-related issues,” says Jack Choros of CPI Inflation Calculator.
A no-fee mortgage may be a smart tactic if you don't plan to stay in one place for a long time or plan to refinance quickly.
“If I am looking to move in a year or two, or think rates might be lower and I might refinance again, then I want to minimize my costs,” says Matt Hackett, operations manager at EquityNow. But "if I think I am going to be in the loan for 10 years, then I want to pay more upfront for a lower rate.”
What additional fees should you be prepared to pay?
As with any large purchase, whether it’s a car or computer, there's no flat “this is it” price. Hidden costs always lurk in the fine print.
“Most of the time, the cost for credit reports, recording fees, and flood-service fee are not included in a no-fee promise, but they are minimal,” says DiBugnara. “Also, the appraisal will always be paid by the consumer. They are considered a third-party vendor, and they have to be paid separately.”
“All other costs such as property taxes, home appraisal, homeowners insurance, and private mortgage insurance will all still be paid by the borrower,” adds Yates.
It’s important to ask what additional fees are required, as it varies from lender to lender, and state to state. The last thing you want is a huge surprise.
“Deposits that are required to set up your escrow account, such as flood insurance, homeowners insurance, and property taxes, are normally paid at closing,” says Jerry Elinger, mortgage production manager at Silverton Mortgage in Atlanta. “Most fees, however, will be able to be covered by rolling them into the cost of the loan or paying a higher interest rate.”
When does a no-fee mortgage make sense?
For borrowers who want to save cash right now, but don’t mind paying more over a long time frame, a no-fee mortgage could be the right fit.
“If your plan is long-term, it will almost always make more sense to pay the closing costs and take a lower rate,” says DiBugnara. “If your plan is short-term, then no closing costs and paying more interest over a short period of time will be more cost-effective.”