The myth of the no-fee mortgage

Taking out a mortgage to buy a home or to refinance an existing mortgage usually comes with a variety of loan fees and closing costs. Some lenders will advertise a “no-fee loan” to entice borrowers who don’t want to pay the fees, but is it really a good deal? No-fee mortgages still have fees, but they are built into to the interest rate of the loan. Educated consumers will want to carefully analyze any “no-fee” offer, as your lender is still getting paid.

Mortgage Closing Costs

When closing a mortgage, there are a variety of fees that the borrower must pay. Many of these are paid to the lender for originating your loan, but a number of them are paid to 3rd party service providers. Lenders will often charge an origination fee as a percentage of your loan amount. They will also tack on other fees like an underwriting fee, documentation fee or other similarly-named administrative fees. Regardless of what they are called, add them all up, and that is what your lender is charging you for originating the loan at a particular interest rate. One of more of these may be negotiable if you are comparing loan offers from various companies.

home mortgage

There are a number of third party companies that are also necessary to get a new mortgage. Your lender will hire an appraiser to value the home and will need you to pay for a new title insurance policy for them. You also need an escrow company to facilitate closing of the loan and disbursement of proceeds. There are likely other charges for things like flood certification, credit reports or document transit and recording. All of those fees must be paid, and there isn’t going to be any negotiation here, as most of these companies “charge what they charge.”

How does a “no-fee mortgage” work?

Make no mistake, everyone involved in your mortgage still gets paid, even on a “no-fee mortgage.” None of these parties work for free, and they only work on loans that will provide them with income.

Mortgages are offered at a range of prices. The current market interest rate is known as the “par rate.” When a lender issues a loan “at par,” there is no additional money available. However, lenders also offer loans above and below par rates, and are willing to pay a premium or receive a payment for those different rates.

Here is a really simple example. Let’s say you borrow $400,000 at the par rate of 5.0%. At par, there is no additional yield spread available. However, they also offer a rate of 5.25% with a yield spread premium back to you of $5,000 and a 4.75% rate if you pay them an additional $5,000. If your loan closing costs total $5,000, you can take the higher rate of 5.25% and pay no fees, but the fees are still being paid via a higher interest rate.

Does a “no-fee mortgage” make sense?

No-fee mortgages can make sense. The most obvious case is when the borrower is short on cash to pay their own closing costs or maybe needs to maximize the dollars that they have available for their down payment.

If you have the cash available for your closing costs, you need to analyze the loan terms very carefully. You are paying a higher than market interest rate for the life of the loan for the privilege of paying no fees at closing. Effectively you have financed your closing costs for the life of the loan, and if you calculate your interest payments on that amount, you’ll see that you are actually paying a lot more over time than if you had just paid the fees upfront. If you hold the mortgage for a relatively short period, you may get an OK deal, but if you hold the loan for 10 years, you are definitely overpaying.

When obtaining a mortgage, always remember that no one is working for free. The fees are there, whether you see them or not, as everyone in the transaction needs to be paid. You either pay your closing costs out of pocket at the time of closing, or you build those fees into your loan via a higher than market interest rate.