What is a No-Fee Mortgage
A no-fee mortgage is when a lender charges no fees for applications, appraisals, underwriting, processing, private mortgage insurance and other third-party closing costs typically associated with mortgages.
Breaking Down No-Fee Mortgage
No-fee mortgage fees are built into the interest rate of the loan. The lender will front many of the initial closing costs and fees while charging a slightly higher interest rate over the duration of the loan. This increases the monthly mortgage payment but decreases the upfront cash the buyer pays in addition to the down payment. However, lender no-fee terms vary. Even if a mortgage is marketed as no fee, most lenders will not cover certain taxes, insurance premiums or attorney fees. Also, flood insurance, private mortgage insurance and transfer taxes often are excluded. Another possibility is early repayment or cancellation fees. Lenders may require borrowers to hold a mortgage for a minimum period such as three years, or pay a penalty. And, closing costs may be subject to repayment by the borrower if the loan is closed before a certain date. Another possibility is that a lender could charge a prepayment penalty for making payments ahead of schedule. Such policies protect the bank’s profit and ensure it recoups the advance to cover the initial closing costs.
Saving on these closing costs in a no-fee mortgage could cost thousands of dollars in extra interest over the course of a 30-year mortgage. A no-fee mortgage make financial sense only for short-term loans.
No-fee Mortgage Example
For example, if an applicant seeks to borrow $500,000 to buy a home with a 30-year, fixed-rate mortgages. Bank #1 offers a traditional mortgage at a 4.5 percent fixed interest rate and $3,000 in upfront closing costs. Bank #2 offers a no-fee mortgage, at 5 percent fixed and zero closing costs. The monthly payment with Bank #1 would be $2,533.42. With Bank #2, it would be $2,684.10, or $150.68 more each month. After about three years of payments with Bank #2, the borrower would have paid back the $3,000 the lender paid upfront. After that, the bank earns an additional $150 each month due to the higher rate. For the full, 30-year term of the mortgage, this would mean paying the bank $48,000 more than with Bank #1. However, the shorter the mortgage, the less the total cost. With Bank #2 and owning the property for five years, the added interest from the extra $150 monthly payment would total around $9,000, or $3,000 extra for covering the upfront fees. If interest rates fall, the homeowners could refinance at a lower rate.
However, refinancing would not be an option if rates rise or property values decline.