Paying Closing Costs Up Front

Paying closing costs up front - why would anyone do that when they can get a no cost loan? The answer is simple, you get a lower interest rate when you pay the closing costs of your home loan. Then why have no cost loans become so popular? This is also a simple answer - successful advertising.

No cost loans where the lender pays closing costs are accomplished by selling the consumer a higher interest rate than they actually qualify for. In doing so the lender makes a premium known as yield spread. Yield spread is paid by the secondayr market for the oversold rate. They are willing to pay this premium because they understand that over the course of time the higher interest rate will return a larger profit, so the premium paid up front is justified and business as usual. Where does this fancy footwork leave the consumer who established the new home loan? They have a higher rate than the market truly offers that results in a higher monthly payment for the entire course of the loan.

Point in fact most people do not understand that this is how no cost home loans are accomplished because banks and correspondent lenders are not required to disclose the yield spread made on home loans they originate (brokers are required to disclose this premium), so often times you are sold a home loan without full disclosure of the terms.

Paying closing costs up front ont he other hand results in lower interest rates which result in lower monthly payments. Over time these lower monthly payments will result in savings far larger than the cost of closing you would incur to establish this lower rate. The simple reason this is not discussed in the large financial firms is because they understand their profit margins go up with the sale of no cost loans.

The point of this article is not to deter anyone from a no cost home loan. In certain instances this is a cost effective loan (ie: staying the the home for a short period of time); instead borrowers need to measure their break even points and research all of their options. Do not be opposed to paying closing costs, often times this is the most cost effective solution.