You may see loans advertised as 'no closing cost loans'. While it may be a good deal, you should understand what it means to use a no closing cost loan. It does not mean you’re getting something for free - it just means you don't have to hand over cash right now.
Anytime you borrow money, somebody gets paid. The lender charges you interest, which is easy enough to understand. What about transaction costs? Does the person who connected you to the lender get a fee or commission? Are there other activities that cost money (such as credit checks, appraisals, etc)?
In many cases, yes. Especially for mortgages and other large loans. However, you'll often run across loans advertised as no closing cost loans. If there’s no closing cost, how do the fees get paid?
No Closing Costs = "Higher Rate"
When you use a no closing cost loan, you still pay the fees. You’ll notice that no closing cost loans have higher interest rates. Instead of paying up front in a lump sum, you pay a little bit extra over time.
Depending on how long you’ll keep the loan, you might end up paying a lot more than you would have paid in closing costs.
Brokers also get paid when you use a no closing cost loan. They’re not working for free. Instead, they get paid by the lender, who has a little extra money since they’re charging you a higher rate.
You can see how your payment and total interest costs change with different interest rates using our Loan Amortization Calculator.
When Choosing No Closing Costs is a Good Idea
No closing cost loans are not necessarily bad. They are the right choice in some cases. Of course, it’s nice to get a loan done without writing a big check, but that should not be your greatest concern. Consider no closing costs when:
- Rates are high and you expect them to go lower soon
- You’ll only keep the loan for a few years
When it's a Bad Idea
You should sometimes avoid no closing cost loans. Although it hurts to pay the costs up front, you may be setting yourself up nicely for the long term. Think about the big picture when you evaluate no closing cost loans.
You should generally avoid no closing cost loans when:
- Rates are relatively low, and you expect them to rise
- You’ll keep the loan for many years
- You can afford to buy the cheapest rate possible
How to Get the Best No Closing Cost Loan
If you’re interested in no closing cost loans, be sure to consider all the factors. Then, shop around.
You can often get a variety of quotes from the same broker - some of them might be no closing cost loans and others with different levels of closing costs. With the options in front of you, you’ll see that you can find a level of costs that’s acceptable to you.
You should comparison shop as well. Ask several mortgage brokers as well as your bank or credit union for quotes. You’ll find that they structure closing costs differently, and you can compare how things change if you choose to have no closing costs.
Closing costs are complex, and no closing cost loans are not always the cheapest. Make sure you understand how closing costs work before pulling the trigger.