Thinking About a No-Closing-Cost Mortgage? Do This First

Make sure you understand how you'll actually pay for closing costs.

When you get a mortgage loan, you'll most likely have fees to pay at closing. The average closing costs are usually 2% to 5% of the home's value. That's thousands of dollars up front that you're going to have to pay.

Sometimes, however, lenders will advertise something called a "no-closing-cost mortgage." That's a loan without the customary upfront fees. But just because you don't have to pay the money when you close on the home does not mean the lender is just going to forgo thousands of dollars in fees.

Before you decide to go through with a no-closing-cost loan, make sure you understand exactly how those fees will end up getting paid.

There's no such thing as a fee-free mortgage loan

Costs associated with getting a mortgage can include fees charged by your lender, such as origination fees. But there are other expenses as well, including appraisal fees and title insurance. Even if you have a no-closing-cost loan, lenders will still want you to pay for all of these costs. That's why they typically do one of two things to make sure you cover the fees:

• Add them on to your loan balance
• Raise the interest rate that you pay over the life of the loan

In either of these scenarios, you're ultimately just stretching out the time that it takes you to pay closing costs. And in some cases, this could actually end up costing you more money over your loan repayment period.

Say, for example, that you've decided on a 30-year loan and plan to borrow $250,000 with an interest rate of 3.20% and closing costs of $7,500. If your lender has offered a no-closing-cost loan, those costs would be added to your principal balance, meaning you end up owing $257,500.

If you had paid off your closing costs up front and only borrowed $250,000, your monthly mortgage payments would have been $1,081. And your total costs over the life of your loan (including interest and principal) would have been $389,220.

But once you add on closing costs, your $257,500 loan would leave you with monthly payments of $1,114 and total costs of $400,897 over your repayment time. The $7,500 in closing costs would ultimately cost you $11,677.

Now you may decide that you'd rather pay an extra $33 per month and an extra $4,177 over 30 years in order to avoid having to come up with $7,500 at the time of closing. That may make a lot of sense, especially since it can be difficult to come up with closing costs on top of a down payment. You also have to consider a variety of other expenses of home ownership that are likely to come up as you move into your new home.

But before you decide a no-closing-cost mortgage is right for you, it helps to realize that one way or another, you end up paying closing costs. You'll have to think carefully and decide what's best for you: paying the closing costs up front and being done with them, or dealing with the costs that come with adding them into your mortgage.