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The Truth About "No Closing Cost" Loans

There is, in my town, a particularly obnoxious mortgage broker who uses phrases like, “no brainer”, “rip-off”, “racket” about his own industry. Well, I’ll agree with him on one thing: He’s hoping you’re the no brainer because what he offers is not necessarily good and how he sells it is an absolute lie.

Normally I have only good things to say about even my competition but in this case let’s call it like it is – misleading. However it has stirred up a lot of talk and I get a lot of phone calls about this particular service of No Closing Cost Loans. I also find it funny that he also has an advertisement on air looking for loan officers because his “top performers” earn “a half-million a year”. Still think he’s paying your closing costs? Far from it friend!

Here is the truth about no closing cost loans: There are closing costs and you pay them.

The way a no closing cost refinance works is simple: The interest rate is raised enough to cover the closing costs and the broker uses the proceeds from the financing of your loan to pay them. He uses the rebate he gets from the lender for charging you a higher interest rate.

Ever wonder how a mortgage broker gets paid? Certainly you didn’t think an entire office of people could operate from that 1% origination fee, did you? Well, they don’t.

The fees that go to the broker generally include the origination fee (which is somehow split with the loan officer), the admin or processing fee (which generally goes almost entirely to the processor), a broker fee if it is charged (used to offset office expenses such as advertising or general office expenses), and something brokers don’t really want you to know about called the Yield Spread Premium.

YSP

The Yield Spread Premium is a fee paid to the broker by the lender for using their services. It’s the difference between the wholesale cost and the retail price you pay. Just like a car dealer marks up the price of the car to make a profit so do mortgage brokers. It’s really what makes the difference between survival and failure.

As a general rule loan officers receive a portion (their split) of the YSP and the brokerage keeps the rest for income. Very much the way a car dealership would do with the dealer incentive received from the car manufacturers. It’s usually somewhere between 1/2% and 3% of the loan amount.

Since you don’t have to pay for it out of pocket it’s a very good way to pay these fees. (As a side note, even with the YSP current long term study results show that you are saving money by going through a broker over going directly to the bank or lender!)

Because of a ridiculous set of laws in many states including Georgia usually called a “fair lending act” mortgage broker’s hands are tied about how this YSP can be charged. That’s why your refinance would need to be something like $250,000 or more in order for you to fully enjoy the no closing cost refinancing we’re talking about.

Since YSP is a percentage of the total loan amount and in Georgia and other states with a “fair lending act” limit the amount of YSP and other fees brokers and lenders can charge – if you’re poor you’re paying closing costs! Way to go state congressmen! And Fair Lending Acts are supposed to equalize the playing field? Actually, if you’re poor they take you OFF the playing field in many cases. Anyway, I digress.

Every closing has it’s costs. We’re talking about refinancing instead of acquisition so the largest fee of all, real estate broker fee, is not a consideration. Closing costs include attorney fees, title fees, broker fees, lender fees, courier fees, and such. Maybe some brokers charge “junk fees” but I have a feeling they aren’t junk to the person needing that fee to eat. Courier fees have been called junk fees but I imagine the courier wouldn’t agree. I suppose junk fees could be document preparation fees, package review fees, etc., except where those fees are legitimized by some complications with the loan. Again, I digress.

Cutting to the chase – fees on a $150,000 refi generally amount to about 3% of the loan amount. However, the borrower will, unless arrangements are made to “waive escrows” be required to pay taxes and insurance in advance. On that same loan amount about 1.5% of the loan amount will be required for these escrow fees. These fees do not go to the lender or the broker. Taxes go to the government and insurance goes to the insurance broker or company.

So on a $150,000 you can expect to pay a total of about 4.5% in closing costs. (Still a far cry from the 7% real estate broker fee that you would pay if this were an acquisition.) 4.5% of $150,000 is $6750. Since you would already be paying all but about $1500 out of pocket or out of the proceeds of your loan the difference that the broker would need to “cover” would be about $5250.

YSP pays the broker about 1% for every 1/2% increase in the rate. So let’s say your initial rate is 5.5% paying the broker back 1%. In order for you to not have to pay any closing costs the interest rate would need to be calculated to cover the costs by increasing the interest rate enough for the YSP to cover the $5250. Since we know $1500 is 1% of the loan amount and 1/2 pays 1 on YSP let’s just divide 5250 by 1500 to get 3.5. Since YSP pays 1 for 1/2 let’s divide 3.5 by 2 and end up with 1.75.

Now let’s add 1.75 to 5.5 (your initial rate) to get 7.25. Some investors do not allow interest rates this high so you may have to pay the taxes and insurance from the cash out from your loan which will also result in a lower interest rate.

Confused?

YSP is broker commission. If the broker is paying closing costs, or even reducing closing costs, they obviously need to make more commission – NOBODY WORKS FOR FREE. So if the YSP is increased it increases your interest rate. Got it? No closing costs means you pay for it, boy do you pay for it, over the life of the loan. If you’re keeping your loan for more than 5 years you’re shooting yourself in the long-term foot if you’re trying to save money “over the life of the loan”.

Keep in mind that most people keep a loan for only 3 to 5 years. In this case it makes sense to go for a no closing cost loan because you’ll never pay them back. However you may not be able to qualify for a no closing cost loan because of something called Debt To Income Ratio and I’m not even going to get into DTI right now!

Suffice it to say if you are looking to refinance a $70,000 house you’re paying closing costs because there isn’t enough YSP to pay them. The higher the amount of your loan the lesser the increase in interest rate and thus monthly payment. If you want to see how it would work on your house give me a call and I can send you the scenario.

So, who are you going to call when you want a No Closing Cost Refinance? Me (the guy who bares it all) or Bozo the Blabber Mouth Broker who shouts at everyone on the radio and calls you and everyone in his industry and mostly real estate agents complete idiots?

My name is Ken and my number is 678-439-8683. If I’m not available one of my many well trained staff members will help you.