Understanding Low-Cost Loans

When structuring my client’s loans, I will typically recommend loan strategies with little if any closing costs.  Depending upon loan size and other factors, a no-cost loan may not be available.  However, a loan strategy where a significant portion of the closing costs are credited back to the borrower is most often an option.

I’m often asked how it is possible to refinance a loan without paying all of the closing costs.  A loan with limited closing costs seems too good to be true, so many become skeptical.  Below is a detailed explanation of how a Low-Cost loan works and the benefits it offers.  (NOTE:  City Creek Mortgage does not charge you any closing costs.  We are 100% compensated on a fixed income basis by our investors, not by our clients.)

A Low-Cost Loan Explained:

There are always fees associated with doing a mortgage.  Appraisers, title companies and underwriters all require  payment for their services.  On a typical $165,000 mortgage, the total for these is approximately $2,366.  Then, there is either a cost or a credit associated with each interest rate.  For example, , and a 4.125% interest rate may offer a credit of 1% of the loan amount.Alternatively, there are also interest rates that offer a credit.

Therefore, with a $165,000 loan, you will pay the following:

A 3.75% interest rate may have a cost of 1% of the total loan amount.

Basic Closing Costs $2,366
Cost for interest rate of 3.75% $1,650
Total Closing Costs $4,016

A 4.125% interest rate may offer a credit of 1% of the loan amount.

Basic Closing Costs $2,366
Credit for Interest Rate of 4.125% ($1650)
Total Closing Costs $716


Difference in close costs:  $4,016 – $716 = $3,300


The Benefits of a Low-Cost Loan:

When comparing a loan where someone is paying a higher level of closing costs to achieve a slightly lower interest rate, the loan amounts must be adjusted to reflect equal cash needed at closing.  In other words, if there is a difference in loan costs between the two options of $3,300, the Low-Cost option will have a loan amount that is $3,300 lower.  That will most effectively show the true cost of paying a higher level of closing costs to obtain a lower interest rate.  Therefore, we would compare a balance of $168,300 at a rate of 3.75% vs. a loan amount of $165,000 at a rate of 4.125%.  The results are as follows:

Full-Cost Option:     $168,300 @ 3.75% has a P&I payment of $779.42

No-Cost Option:     $165,000 @ 4.125% has a P&I payment of $799.67

By paying an additional $3,300 in closing costs, the monthly payment will be $20.25 lower than the Low-Cost option.

Therefore, the breakeven point is 162 months ($3,300 / $20.25 = 162.96 months).

If the loan will be in place for at least 13.5 years, then paying the fees for the lower rate may be the best option.  However, that is very rare and does not account for the option to move the rate lower again should interest rates continue to fall without losing the significant amount of closing costs paid for the loan.  Nor does it take into consideration the additional tax benefits the higher interest rate of a Low-Cost loan offers.

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