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No-Closing-Cost Mortgages: Understand the Risks

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If you’re a savvy shopper, you’re probably always looking for ways to spend as little money as possible. But when it comes to paying closing costs for your new house, spending less may not be the best idea. Closing costs are the assortment of fees that a homebuyer pays when closing on the transaction. They could include such charges as the cost of the appraisal, title insurance and tax service-provider fees. They also could include fees that you pay in advance, such as property taxes and homeowners insurance.

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If that sounds like an expensive proposition, you’re right. Closing costs add approximately $6,250 to the median house purchase in the United States, according to an October 2018 analysis by first-time homebuying website, RealEstate.com and small-business marketplace, Thumbtack. Add that to the down payment, which could be as low as 3.5% of the home’s purchase price, or a minimum of 20% to avoid mortgage insurance, and you’re talking about some serious cash.

So if someone told you that you qualified for a “no-closing-cost mortgage,” it’s easy to see why that might sound appealing. However, before signing on the dotted line, you should understand the risks.

The idea of paying no closing costs sounds great and it catches people’s attention, said Larry Locke, a mortgage broker with Pro-Funders Inc., in Murrieta, Calif. “However, there’s no such thing as a free lunch. The cost has to be dealt with somewhere.”

A no-closing-cost mortgage is not, in fact, free. Instead, it’s a way of structuring a mortgage loan so that the lender recoups the closing-cost fees in one of two ways: either by charging a higher interest rate on the mortgage than it would otherwise, or by adding the closing costs to the amount of your loan. With either option, you can avoid out-of-pocket payment for the closing costs. Instead, the closing-cost fees will be spread out — and you will pay them — over the life of the loan.

Is a no-closing-cost mortgage a good option for first-time homebuyers?

You may be wondering if a no-closing-cost mortgage is the right option for you. It depends. There are some situations when a no-closing-cost mortgage might be ideal.

You don’t have a lot of cash on hand. Many first-time homebuyers find it extremely challenging to save enough money for a down payment and closing costs. If you don’t have a lot of savings, a no-closing-cost mortgage could be your only option for becoming a homeowner now rather than waiting until you are able to save more money.

You need your cash for other financial priorities. Even if you do have the money to spend on the down payment and closing costs, you may decide that you’d rather use your money for something else that’s more urgent. Maybe you have medical expenses. Perhaps you’d rather have the peace of mind that a large emergency fund brings. Whatever your reason, you may decide that you’d rather not tie up all of your money in buying a house.

You plan to sell the house soon. There’s another situation in which paying no closing costs upfront might make sense. If the lender covers the closing costs on a 30-year mortgage by giving you a higher interest rate, those closing costs will be stretched out over the life of the loan in the form of higher interest. However, you won’t be making those interest payments all at once. Instead, you’ll be paying a little toward them each month for the next 30 years. On the other hand, if you pay the closing costs upfront, you’ll pay for the closing costs immediately. If you sell the house in the first few years after you buy it, you may end up spending more by paying the closing costs upfront than you would have spent on the additional interest for those few initial years.

“If a homebuyer is only going to stay in the house five years, the financial harm of a higher interest rate is less impactful than if they’re going to stay in that house for 30 years. It amplifies out over time,” Locke said.

Say you’re considering two mortgage offers for a $250,000, 30-year fixed rate loan. Lender A offers you a conventional mortgage loan with a 4.5% interest rate and $3,000 in closing-cost fees. Lender B offers you a no-cost mortgage with a 5% interest rate. While the loan with the higher interest rate would save you money in closing costs, it would cost $75.34 more per month, or $904.08 per year. For the first three years of the loan, you’ll spend less overall with the no-closing-cost loan. However, by the end of Year Four, you would have spent approximately $3,616.32 more in mortgage payments with the no-closing-cost loan — $600 more than you saved initially in closing costs. If you pay the closing costs upfront rather than take the no-closing-cost option, you’ll come out ahead once you are three years and four months into the loan.

It’s also important to consider the cons of taking out a no-closing-cost mortgage.

You may spend more money on the loan over time. If you’re planning to stay in the house for 30 years, a higher interest rate means you will spend significantly more in interest over the mortgage term. Even if the lender takes care of closing costs by wrapping them into the loan rather than charging you a higher interest rate, you’ll be financing the closing costs, so you’ll be paying interest on them, rather than simply paying them upfront.

Your monthly payments may be higher. Whether you’re financing the closing costs by rolling them into the loan, or you agree to a higher interest rate to cover the costs, your monthly mortgage payments may be higher with a no-closing-cost mortgage than they would be otherwise. If your budget is already tight, a larger mortgage payment might not be a good option for you.

There are also other factors to consider whenever you shop around for a mortgage loan and compare multiple offerings.

  • Always understand all fees that you will be responsible for either at closing or throughout the life of the loan. You can find a listing of those fees in the Closing Disclosure, a document sent by your lender that details the loan. If you don’t understand any of the charges, ask the lender to explain them.
  • Check for prepayment penalties. Some loans require you to pay a specified amount if you pay off the loan early or refinance. In some cases, you may even be charged a prepayment penalty if you sell the house before the full term of the loan is up. If you’re considering a loan with a prepayment penalty, make sure you understand what circumstances would trigger the penalty, and how much you’d be expected to pay.

Alternative lower-cost loans

If you don’t have a lot of cash available for buying a house, there are other ways that you can decrease the amount of money you need upfront. Rather than take out a no-closing-cost mortgage, you can look for a loan program that lets you make a low down payment to get the financial relief that you need.

FHA loans are offered by private lenders and insured by the Federal Housing Administration (FHA). Under the FHA loan program, you can put down as little as 3.5% on a house.

VA loans are offered by private lenders and guaranteed by the U.S. Department of Veterans Affairs (VA). The program, which is available to veterans, servicemembers and eligible surviving spouses, may offer loans that require no down payment.

USDA loans are backed by the U.S. Department of Agriculture (USDA) and designated for borrowers in rural and suburban parts of the country, as defined by the agency. Under the USDA loan program, homebuyers may be able to take out a loan while making no down payment.

If becoming a homeowner is important to you, a shortage of cash doesn’t have to derail your plans. For some homebuyers, particularly those who don’t plan to stay in the house long, a no-closing-cost mortgage could be a good move. However, make sure you understand the risks and the overall costs that come with them — or any other low-cost alternative.

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How to Recover From Missed Mortgage Payments

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understanding good faith estimate vs loan estimate
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Can you bounce back from a missed mortgage payment or two? The answer is yes, but there’s work involved. After all, your payment history has the greatest impact in determining your credit score.

Falling behind on your mortgage payments can affect your credit and finances, and you could lose your home to foreclosure. It’s critical to be proactive and not wait until it’s too late to get help.

How missed mortgage payments affect your credit

In most cases, mortgage lenders give you a 15-day grace period before charging a fee — often around 5% of the principal and interest portion of your monthly payment — for late payments. But your credit history typically isn’t impacted until you’re at least 30 days behind on a mortgage payment. At this point, your mortgage servicer may report your late mortgage payment to the three major credit reporting bureaus: Equifax, Experian and TransUnion.

Your credit score could drop by 60 to 110 points after a late mortgage payment, depending on where your score started, according to FICO research. Being 90 days late on your loan could lower your score by another 20 points or more.

It can take up to three years to fully recover from a credit score drop after being a month behind on your mortgage, FICO’s research found. Once you’re three months behind on your mortgage, that time can increase to seven years.

Recovering from missed mortgage payments

Falling behind on your mortgage can be a frustrating and scary experience, particularly if you’re facing the threat of foreclosure. Here are some options to help you get back on track after missed mortgage payments:

  • Repayment plan. Your loan servicer agrees to let you spread out your late mortgage payments over the next several months to bring your loan current. When your upcoming payments are due, you’d also pay a portion of the past-due amount until you catch up.
  • Forbearance. Your servicer temporarily reduces or suspends your monthly mortgage payments for a set amount of time. Once the mortgage forbearance period ends, you’ll repay what’s owed by one of three ways: in a lump sum, a repayment plan or by modifying your loan.
  • Modification. A loan modification changes your loan’s original terms by extending your repayment term, lowering your mortgage interest rate or switching you from an adjustable-rate to a fixed-rate mortgage. The goal is to reduce your monthly payment to a more affordable amount.

Be proactive about getting back on track and reaching out to your lender for help instead of waiting until you get late payment notices. If you think you’ll be behind soon or are already a few days behind, make contact now and review your options.

Extra help for homeowners affected by COVID-19

If you’re behind on mortgage payments because of a financial hardship due to the coronavirus pandemic, you may qualify for a mortgage relief program through the Coronavirus Aid, Relief and Economic Security (CARES) Act.

Homeowners who have federally backed mortgages, and conventional loans owned by Fannie Mae or Freddie Mac, can request mortgage forbearance for up to 180 days. They can also request an extension for up to an additional 180 days.

Federally backed mortgages include loans insured by the:

  • Federal Housing Administration (FHA)
  • U.S. Department of Agriculture (USDA)
  • U.S. Department of Veterans Affairs (VA)

Reach out to your mortgage servicer to request forbearance. Even if your loan isn’t backed by a federal government entity, Fannie Mae or Freddie Mac, your servicer may offer payment relief options. You can find your servicer’s contact information on your most recent mortgage statement.

How many mortgage payments can you miss before foreclosure?

Your lender can begin the foreclosure process as soon as you’re two months behind on your mortgage, though it typically won’t start until you’re at least 120 days late, according to the Consumer Financial Protection Bureau. Still, it’s best to check your local foreclosure laws since they vary by state.

Here’s a timeline of how missed mortgage payments can lead to foreclosure.

30 days late

Your lender or servicer reports a late mortgage payment to the credit bureaus once you’re 30 days behind. Your servicer will also directly contact you no later than 36 days after you’re behind to discuss getting current.

45 days late

You’ll receive a notice of default that gives you a deadline — which must be at least 30 days after the notice date — to pay the past-due amount. If you miss that deadline, your servicer can demand that you repay your outstanding mortgage balance, plus interest, in full.

Your mortgage servicer will also assign a team member to work with you on foreclosure prevention options. This information will be communicated to you in writing.

60 days late

Once you’re 60 days late, expect more mortgage late fees, as you’ve missed two payments. Your servicer will send you another notice by the 36th day after the second missed payment. This same process applies for every month you’re behind.

90 days late

At 90 days late, your servicer may send you a letter telling you to bring your mortgage current within 30 days, or face foreclosure. You’ll likely be charged a third late fee.

120 days late

The foreclosure process typically begins after the 120th day you’re behind. If you live in a state with judicial foreclosures, your loan servicer’s attorney will file a foreclosure lawsuit with your county court to resell the home and recoup the money you owe. The process may speed up in nonjudicial foreclosure states, because your lender doesn’t have to sue to repossess your home.

You’re notified in writing about the sale and given a move-out deadline. There’s still a chance you can keep your home if you pay the amount owed, along with any applicable legal fees, before the foreclosure sale date.

Can you get late mortgage payment forgiveness?

If you’ve otherwise had a good payment history but now have one missed mortgage payment, you could try writing a goodwill adjustment letter to request that your servicer erase the late payment information from your credit reports.

Your letter should include:

  • Your name
  • Your account number
  • Your contact information
  • A callout of your good payment history prior to missing a payment
  • An explanation of what led to the late mortgage payment
  • The steps you’re taking to prevent late payments in the future

End the letter by requesting that your servicer remove the late payment from your credit reports, and thank your servicer for their consideration. Print, sign and mail your letter to your servicer’s address.

The letter is simply a request; your servicer isn’t required to grant late mortgage payment forgiveness. If your servicer agrees to remove the late payment info from your credit reports, your credit scores may eventually increase — so long as you continue to make on-time payments.

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Mortgage

What Is the Minimum Credit Score for a Home Loan?

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If you’re hoping to become a homeowner, your credit score may hold the keys to realizing that dream. Knowing the minimum credit score needed for a home loan gives you a baseline to help decide if it’s time to apply for a mortgage, or take some steps to boost your credit first.

It’s possible to get a mortgage with a score as low as 500 if you can come up with a 10% down payment. Keep reading to learn the minimum credit score requirements for the most common loan programs.

What are the minimum credit scores for home loans?

Your credit score plays a big role in determining whether you qualify for a mortgage and what your interest rate offers will be. A higher credit score means you’ll likely get a lower rate and a lower monthly mortgage payment.

There are four main types of mortgages: conventional loans, and government-backed loans insured by the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA). Conventional loans, which are the most common loan type with guidelines set by Fannie Mae and Freddie Mac, have a credit score minimum of 620. Although some loan programs don’t specify a minimum credit score needed to qualify, the approved lenders who offer them may set their own minimum requirements.

The table below features the minimum credit scores for these home loans, along with minimum down payment amounts and for whom each of the loans is best.

Loan type

Minimum credit score

Minimum down payment

Who it’s best for

Conventional6203%Borrowers with good credit
FHA500-579 with 10% down payment
580 with 3.5% down payment
10% with a score of 500-579
3.5% with a minimum score of 580
Borrowers who have bad credit and are purchasing a home at or below their area FHA loan limits
VANo credit minimum, but 620 recommendedNo down payment requiredActive-duty service members, veterans and eligible spouses with VA entitlement
USDA640No down payment requiredBorrowers in USDA-eligible rural areas with low- to moderate-incomes

What is a good credit score to buy a house?

Meeting the minimum score requirement for a home loan will limit your mortgage options, while higher credit scores will open the doors to more attractive rates and loan terms. A good credit score can also provide you with more choices for home loan financing.

  • 740 credit score. You’ll typically get your best interest rates for a conventional mortgage with a 740 (or higher) credit score. If you make less than a 20% down payment, you’ll pay for private mortgage insurance (PMI). PMI protects the lender in case you default on your home loan.
  • 640 credit score. Rural homebuyers need to pay attention to this benchmark for USDA financing. Exceptions may be possible with proof that the new payment is lower than what you’re paying for rent now.
  • 620 credit score. The bare minimum credit score for conventional financing comes with the largest mark-ups for interest rates and PMI.
  • 580 credit score. This is the bottom line to be considered for an FHA loan with a 3.5% down payment.
  • 500 credit score. This is the lowest credit score you can have to qualify for an FHA loan, but you must put 10% down to qualify.

Annual percentage rates by credit score

Your mortgage rate is a reflection of the risk lenders take when they offer you a loan. Lenders provide lower rates to borrowers who are the most likely to repay a mortgage.

Here’s a glimpse of the annual percentage rates (APRs) and monthly payments lenders may offer to borrowers at different credit score tiers on a $300,000, 30-year fixed loan. APR measures the total cost of borrowing, including the loan’s interest rate and fees.

FICO Score

APR

Monthly Payment

760-8503.011%$1,267
700-7593.233%$1,303
680-6993.410%$1,332
660-6793.624%$1,368
640-6594.054%$1,442
620-6394.6%$1,538
*Based on national average rate data from myFICO.com for a $300,000, 30-year, fixed-rate loan as of May 4, 2020.

As the credit score ranges fall, the interest rates are higher. Borrowers with a score of 760 to 850, the highest range, saw an average monthly payment of $1,267. Borrowers in the lowest credit score tier of 620 to 639 saw their monthly payment jump to $1,538. The extra $271 in monthly payments adds up to an additional $97,560 in interest charges over the life of the loan.

Steps for improving your credit score

Now that you have an idea of the extra cost of getting a minimum credit score mortgage, follow some of these tips that may help boost your score.

  • Make payments on time. It may seem obvious, but recent late payments on credit accounts hit your scores the hardest. Set your bills on autopay if possible to avoid forgetting to pay one.
  • Pay off balances monthly. Try to pay your entire balance off each month to show you can manage debt responsibly.
  • Keep your credit card balances low. If you do carry a credit card balance, charge 30% or less of the available credit limit on each account.
  • Have a mix of different credit types. Mortgage lenders want to see you can handle longer-term debt as well as credit cards. A car loan or personal loan will help demonstrate your ability to budget for installment debt payments over time.
  • Avoid applying for new accounts. A credit inquiry tells your lender you applied for credit. Even if you were applying to get your best deal on a credit card or car loan, multiple inquiries could drop your scores, and give a lender the impression you’re racking up debt.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.