No Closing Cost Mortgage: What Is It and When Is It Used?

As if saving up enough money for a sizable down payment wasn’t hard enough, you also have to consider the added expense of closing costs when purchasing a home. But there’s a way to avoid paying closing costs up front when you close on a house through a no closing cost mortgage.

While this solution may make sense for some buyers, it may not work for everyone. So here’s everything you need to know about no closing cost mortgages and how to determine if it’s the right option for your financial situation.

What is a no closing cost mortgage?

A no closing cost mortgage is a type of mortgage that doesn’t require you to pay your closing costs up front in a lump sum at the time of closing. Closing costs are the costs associated with closing your mortgage loan and can cost you thousands of dollars on top of your down payment.

How to calculate potential closing costs?

The exact amount you will owe in closing costs on the closing day depends on various factors. Generally speaking, you can expect to pay 3% to 5% of the total value of the loan in closing costs. So let’s split the difference and say that you have to pay 4% in closing costs on a loan with a value of $250,000. You will owe $10,000 in closing costs on top of a minimum down payment of 3.5% or about $9,000 for a total of $19,000.

Yes, in this case, it seems a bit unorthodox that your closing costs would be higher than your actual down payment -- but here’s a breakdown of some of the different expenses that are covered by closing costs and how much you can expect to pay for each one:

Loan origination fee: 1% of the loan or $2,500 in this case
Mortgage broker fee: 1% of the loan or $2,500 in this case
Discount fee: Up to 2% of the loan or $5,000 if you want to negotiate a lower interest rate
Processing fee: Anywhere between $300 and $900
Underwriting fee: Anywhere between $300 and $900
Application fee: Anywhere between $100 and $350
Lock-in fee: Anywhere between $100 and $300 to lock in your interest rate at the time of pre-approval
Credit report fee: Anywhere between $20 and $40 to run your credit report
Appraisal fees: Anywhere between $350 and $500
Inspection fees: Anywhere between $300 and $500
Title insurance: Anywhere between $300 and $1,500
Escrow fees: Anywhere between $300 and $700
Notary fees: Anywhere between $100 and $150

While this might sound like a bunch of minor charges, they add up quickly. If we add up all of the lower estimates with no discount points, you still end up with almost $7,000 in closing costs -- which is a great deal since it’s less than 3% of your loan amount of $250,000.

How do no closing costs mortgage work?

Now that you understand how much closing costs are, you may be wondering how you can avoid paying them. The bad news is that there’s no way to avoid paying them unless the seller covers them, which isn’t likely to happen in the seller’s market we have now.

The good news is that a no closing cost mortgage allows you to avoid paying them upfront all at once. Instead, you pay throughout the term of your loan in exchange for a higher loan amount and a higher interest rate. As a result, you end up paying less at the time of closing but more over the loan’s lifetime.

What are the pros of a no closing cost mortgage?

There are several benefits of no closing cost mortgages that make them an ideal option for many people, including:

The biggest pro of a no closing cost mortgage is that the closing process is more affordable for those that may struggle to come up with the costs to initially purchase a home. This type of closing process is especially beneficial for first-time homebuyers who often work to save up enough money for a down payment on their own since they’re unable to use the profits of the sale of an existing home to cover these costs.
Another pro of a no closing cost mortgage is that you can reach your break-even point earlier in the payment process than you would otherwise.

What are the cons of a no closing cost mortgage?

At the same time, there are several disadvantages of no closing cost mortgages that may not make sense for a lot of people, including:

The biggest con of a no closing cost mortgage is that you’re likely to end up paying more over the life of the loan since the closing costs are wrapped into the value of the loan.
For instance, say you went with a no closing cost loan for your loan value of $250,000 -- that amount would then increase to $260,000 to cover the $10,000 in closing costs. While this may not seem like much, this could end up costing you thousands of dollars in interest over several years.
Speaking of interest, another con of a no closing cost mortgage is that it typically comes with less favorable terms, notably a higher interest rate in exchange for the lender initially covering these costs for you.
For instance, say that you receive an interest rate of 3% for your $250,000 loan. If you go with a no closing cost mortgage instead, your lender will likely increase your interest rate to 3.5%. Again, half of a percentage point may not seem like much, but it will definitely cost you over the typical 15 or 30-year mortgage term.

Does a no closing cost mortgage make sense for you?

Unfortunately, there is no simple answer to this question as it depends on your financial situation. However, if you have limited liquidity and really cannot afford to pay thousands of dollars in closing costs on top of a down payment, a no closing cost mortgage may make buying a home a more realistic goal. Additionally, if you only plan on owning the home for a short amount of time -- between three to five years -- it may make sense to go with a no closing cost mortgage as you won’t end up paying that much more over the relatively short lifetime of the loan.

On the other hand, if you can afford to pay closing costs now, it often makes sense just to bite the bullet and pay them upfront. Additionally, if you are planning on owning the home for a long time -- longer than five years -- it may make sense to pay the closing costs upfront rather than spending more money on monthly payments and interest-related costs throughout the loan’s lifetime.

Other ways to help make your mortgage more affordable

If you’re looking to make the home buying process more affordable, going with a no closing cost mortgage isn’t your only option. You can take several steps throughout the process to get the best terms and save as much money as possible.

You should shop around with different lenders to find the best interest rate and closing costs. That said, you should consider additional factors when deciding on a lender that goes beyond interest rates and loan terms. For instance, is the lender being transparent with you about loan terms and requirements? Are they a reputable lender with good references and reviews? Do they have a good reputation regarding their customer service? These are all things to consider before signing on the dotted line.
You can negotiate closing costs with your lender and other related costs from the appraisal, inspection, and title search.
You can increase your offer on the home to incentivize the seller to cover your closing costs. That way, you can pay a little more in terms of your total loan amount without dealing with the higher interest rates that typically come with a no closing cost mortgage.
You can research and apply for federal or state grants and assistance that often help first-time homebuyers cover closing costs.
If you’re a veteran, you can apply for a mortgage loan from the U.S. Department of Veterans Affairs that doesn’t require a down payment and allows you instead to put your cash reserves towards closing costs alone.

Final thoughts on no closing cost mortgage

It’s up to you whether or not you want to go with a no-closing cost mortgage when buying your home. For first-time homebuyers or buyers who are in it for the short term, this option may make a lot of sense and make homeownership more accessible. But for those looking to maximize long-term investment in a home, a no closing cost mortgage doesn’t make sense.

If you’re still uncertain about your mortgage options, be sure to reach out to the lending experts at Vaster Capital. We can help you navigate through the process and find the best mortgage solution that fits your needs.

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No closing cost mortgage explained