A mortgage on which all settlement costs except per diem interest and escrows
are paid by the lender and/or the home seller. A no-cost mortgage should be distinguished from a
'no-points mortgage,' which will have other settlement costs, and a 'no-cash-outlays mortgage,' on
which settlement costs are added to the loan balance. Calling the latter 'no-cost' is extremely
A true no-cost mortgage is one where the interest rate is high enough to command a rebate from the
lender that covers the closing costs (except for per diem interest and escrows, which borrowers
always pay). In general, they make sense only for borrowers who expect to hold their mortgages for no
more than five years. A borrower with a longer time horizon and who has the cash to pay settlement
costs ought to avoid the no-cost option.
Lenders demand a high interest rate for rebates because they assume they won't enjoy it very long.
The average life of high-interest-rate loans is short. A borrower who pays the high rate for a long
time gets a bad deal. It is akin to a healthy person buying life insurance from a company that mainly
insures diabetics and smokers and prices its insurance accordingly.
The critical number for potential borrowers is the 'break-even period' (BEP) for a no-cost loan,
relative to the same loan with a lower rate on which the borrower pays the costs. Over periods
shorter than the BEP, the no-cost loan has lower costs. Beyond the BEP, the no-cost loan has higher
costs. One important side benefit of no-cost mortgages is that shopping for them is relatively easy.
The shopper needs quotes on only one price dimension the interest rate.