There is no such thing as a no closing cost mortgage.  It simply doesn't exist.  There are always costs to originate a mortgage and no company or bank has the ability to waive costs. 

So, why is company after company and bank after bank advertising no closing cost mortgages if they don't exist?  Because it makes the phone ring and they figure that is half the battle.  Their commercials make it sound like you get a mortgage for free and that makes the phone ring. 

But do you really get a mortgage for free?  No, there are only 3 ways to pay closing costs.  You pay them with your own money, you roll them into your loan, or you increase your rate to pay them.  That is how they can offer a no closing cost mortgage.  They increase your interest rate.  For brokers it is called yield spread premium and for banks it is called service release premium.  Whatever it is called, it is a chunk of money created by increasing your rate.

For some people this may be new information but even for those who knew the interest rate was being bumped, they may not know to what extent.  How much do you think the rate is increased to pay costs?  I have had several people tell me they know the rate is increased but only about .25% or .375% to cover the costs.  The numbers don't lie so let us see just how much it increases.

A good rule of thumb is for every .25% increase in the interest rate, it creates .5% of YSP or SRP.  For example on a $200,000 mortgage, if the rate was increased from 6.0% to 6.25% it would create $1,000.  The rate increased by .25% and it created .5% of the loan amount as money to the originating company.  Multiply $200,000 by .5% and you get $1,000.

On a $200,000 mortgage you would have around $5,000 in closing costs and that includes a 1% origination fee.  This number does not include the escrows or any interest.  The companies offering no closing cost refinances usually do not include these charges in the estimate so you would have to pay them yourself.  You can see from the example above that a .25% increase in interest rate only creates $1,000 and you have $5,000 in closing costs on a $200,000 mortgage.  A .25% bump in the interest rate would not come close to covering your closing costs.

You would have to increase the rate from 6.0% to 7.25% to pay for $5,000 in closing costs.  And the $5,000 closing cost amount only includes a 1% origination fee.  We all know they need to make more than just 1 point.  So, in order for the originating company to make their 2 points or more you would have to raise the interest rate again to 7.75% to cover all the costs and pay the originating company 2%. 

Many of these companies have a disclaimer that says the loan amount must be $300,000 or more.  As you can see, for a $200,000 mortgage the rate increase is considerable and something that makes it harder for them to sell.  The bigger your loan amount the easier it is to offer the no closing cost mortgages since the YSP or SRP is a percentage of your loan amount.

But is paying an extra $200 a month for a pretend no closing cost mortgage a smart idea?  No, always pay your closing costs and get the lowest rate.  The lower the interest rate you pay to the bank the better off you are.  These guys are just trying to sell you something you don't need.

Good Luck!

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