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Note--I was proud to have this article featured in the August 2007 Financial Planning Association of Minnesota newsletter... 

Some mortgage lenders and brokers are falling over each other to advertise No Fee Mortgages or No Closing Cost mortgages.  I've even heard unscrupulous advertisements stating that "paying any closing costs" during a mortgage transaction is "too much."  These ads, in effect, say lenders, appraisers, and title companies will work for free if you just ask them to.  (Not to mention having the government waive their various real estate transactional taxes!)

This is, of course, just marketing designed to get the consumer in the door to get them emotionally tied to buying a new home or the cash out that can come from refinancing.  To get to the bottom of this, let's examine three phrases which are commonly thrown around in mortgage advertising and often confuse the public:

• No Cash to Close-this just means that any costs associated with the loan are financed into the new mortgage (no adjustment to rate)
• No Fee Mortgage-this often means the lender waives its upfront fees, but has the consumer pay for the appraisal, title, and transactional taxes (slightly higher rate)
• True No Closing Costs-the lender pays all costs associated with the transaction (significantly higher rate)

These are all legitimate ways to structure the financing of a real estate transaction. The first is quite commonly done.  The only drawback in doing so is that the consumer will be charged interest on those costs over the life of the loan.  The second two involve having the lender increase the rate offered to the consumer to make the loan more profitable for sale on the secondary market. This profit then can pay for some or all of real estate transactional fees for the consumer.  Which combination is best?  Of course, the one that costs the consumer the least amount of money to secure the house and the loan!

First, let's break down the costs of a real estate transaction into costs that won't change and costs that are variable.  The costs that won't change are appraisal, title fees, transactional taxes, and deposit of initial funds into the hazard insurance/property tax escrow account.  These should be very similar with each bid you get.  The two things that CAN vary significantly are the rate and here is the key to this--fees to the broker/lender.  They are called a number of different things--application fee, broker fee, origination fee, discount points, etc.  Sort out the third party fees and total the fees to the lender.  These give you the cost of getting the rate.

Let's remember, rates and upfront lender fees on a real estate transaction have an inverse relationship.  When one goes up, the other goes down.  So, what you and your clients have to decide is which combination of rates and fees make sense to keep both the cost of the transaction and the cost of holding the loan as low as possible.  This relates to timeline.  How long will your or your client hold the loan.

And here lies the guessing game.  How long are you or your clients going to hold this loan?  Remember--life happens--divorce, job transfer, better schools district.  The fact is, most consumers are moving more--about every 7 years.  The average life of a loan is about half of that!  However, each consumer's situation is different and the lender's profit is typically unaffected by each of these scenarios.

Take the transactional costs associated with each mortgage offer and divide it by the cost savings monthly of taking the lower rate.  This will give you the number of months to break even in each case.  If you or your client is planning to hold the loan longer than the break even point, they will be then saving money monthly after that point.

The other thing to consider her is products' availability and lender's risk.  These tie to the fine print you see on the bottom of all mortgage ads.  These ads again offer quite a low interest rate for consumers that fit neatly into a box with all positive lending criteria that decrease a lender's risk of doing a home loan.  Positive lending criteria include low loan to (house) value, good credit/assets, measurable job history and income.  If you or your clients don't fit neatly into that box, it helps to know a good mortgage consultant who can think ahead through the underwriting process and make sure the rate quoted at the start of the process matches the liability level of the overall file.  This insures no surprises during the verification process and final rate offer from the lender.  As well, a good mortgage consultant will always present you or your clients with the best way to structure their financing cost based upon the consumers various lending criteria (income/assets/credit/equity position) and estimated timeline for how long they plan to hold the loan.