What Is a No-Fee Mortgage?
Understanding No-Fee Mortgage
The fees a bank would typically charge are built into the interest rate of a no-fee mortgage. The lender covers many closing costs and fees upfront, while charging a slightly higher interest rate over the duration of the loan. This increases the borrower's monthly payment, but decreases the cash the buyer needs to provide upfront in addition to the down payment.
No-fee terms vary among lenders. Even if a mortgage is marketed as "no fee," most lenders will not cover certain taxes (such as transfer taxes) or attorney fees. In addition, flood and private mortgage insurance often are excluded.
With no-fee mortgages, lenders may also require borrowers to hold the loan for a minimum period, or else they will owe an early repayment or cancellation fee. The lender could charge a prepayment penalty for making payments ahead of schedule. The bank may require closing costs be repaid should the loan be closed before a certain date. These policies help to protect the bank's profit.
For borrowers, a no-fee mortgage makes financial sense only if you plan to hold the mortgage for a few years. While borrowers can save on closing costs in the short term, they'll wind up paying thousands of dollars in extra interest over the course of a 30-year mortgage.
No-Fee Mortgage Example
Take for example a mortgage applicant who borrows $500,000 with a 30-year, fixed-rate term. Bank #1 offers a traditional mortgage at a 4.5% fixed interest rate and $3,000 in closing costs. Bank #2 offers a no-fee mortgage at 5% fixed and zero closing costs.
The monthly payment with Bank #1 would be $2,533. With Bank #2, it would be $2,684, or $151 more each month. After less than two years of payments with Bank #2, the borrower will have paid the bank $3,000—enough to cover the closing costs. After that, the bank earns an additional $150 each month thanks to the higher interest rate.
Over 30 years, the borrower would pay Bank #2 $54,000 more than the loan from Bank #1. However, holding the mortgage for a shorter time period will decrease the total cost of the loan. If interest rates fall, the homeowner could refinance at a lower rate. However, refinancing would not be an option if rates rise or property values decline.
Using a mortgage calculator is a good resource to compare these costs.