You have found your dream home; you are negotiating with a builder or developer to buy one of his brand new properties. The builder, now, offers you an opportunity to buy his property if you use his preferred mortgage entity. He says that he will credit you, that is, he will pay your closing costs amounting to X number of dollars (let's say four thousand). He may give you a choice of either paying your closing costs or he may give you upgrades on the house up to the same four thousand-dollar figure. Sounds like a good deal, doesn't it? Well let's see!
We have heard the saying, "You don't get something for nothing." There is definitely no free lunch when it comes to money. When someone offers you something that seems too good to be true . . . well, "you know the rest of the story." How does one pay four thousand dollars toward closing costs on a loan or give an additional four thousand in upgrades? The answer is: it may be factored into the loan interest rate. Here is a little history. In 1992 and 1993 as interest rates came down people refinanced with a vengeance. Home owners who refinanced at the beginning of 1992, dropping their interest rate by let's say 1 to 1 1/4%, refinanced again in mid ' 92, beginning of '93, mid '93 and so forth. Also appearing at this time were ads saying that the refinance would cost nothing . . . "NO-COST LOANS." We could refinance our properties with no money out of pocket. You may have heard commercials stating "we will keep your file available so if interest rates drop by X percent we will automatically refinance your property with no costs to you."
Great news . . . you get lower rates with no costs. However, this is not necessarily so. There was and is a cost. Each time you buy or refinance, you pay certain fees considered "usual and customary." A few of the fees are: title insurance premium, escrow/closing, underwriting, appraisal and credit report fees. Someone must pay these fees. The payer is the borrower, the seller or the lender. If it is you the borrower, it is usually money out of your pocket. If it is the seller, the money will come from the proceeds of the sale of the home. There may be some limitation as to the amount that the seller can pay toward the buyer's closing costs.
If the lender pays the fees, you are paying the fees through a higher interest rate. That is how an entity, be it lender, mortgage broker and/or builder can offer you a rebate as to the loan fees. You pay a higher interest rate on your loan and a rebate for the higher rate is sufficient to cover all or part of the "usual and customary" fees. This program nevertheless may be a very viable alternative.
If you think rates are coming down and another loan refinance may be in the not too distant future, why pay up front fees or increase your mortgage balance by the cost of the new loan? If you think that the period for occupying the current home or new purchase is limited, why pay these fees when you can pay the fees on an installment basis, i.e., a higher monthly payment. You, however, must determine if it will be cost effective in your situation. You should ascertain the non-recurring costs of the loan.
With the hard costs you can proceed with your time frame calculations. Simply multiply the number of months you expect to keep the loan by the dollar difference between your "no costs" mortgage payment and the monthly payment that you would be making if you did not go with a "no costs" loan. For example, on a $200,000 loan the estimated closing costs would be $4,000 with a monthly payment of $1,382. The monthly payment on a "no costs" loan will be approximately $1468. The difference in the monthly payment is $86.00.
For you to realize a cumulative savings with your lower interest rate loan, it will take approximately 46 months of saving $86.00 per month to recoup your up front costs of $4000.00. Therefore, if you plan to keep your loan less than 46 months it may pay to take the "no costs" loan. You and your lender can easily determine the most effective way to take advantage of the current lower interest rates.
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