Which loan is better for a customer: a fee-based loan or loan with no cost?
The answer requires a careful analysis of the terms offered with each option. With a no-cost loan, the interest rate is higher by around a half percent, compared to a fee-based loan. For example, a no-cost interest rate would be 5.5 percent and a fee based loan would be 5 percent. The difference is that no fees are added to a no-cost loan versus 2 to 3 points added to a fee based loan. Since a point equals one percent, a fee-loan of $400,000 costing 2 points would have $8,000 added to the loan balance.
The two loan options should be compared as follows:
The no-cost loan balance would be $400,000 at a rate of 5.5 percent and a monthly payment of $2271.
The fee-based loan balance would be $408,000 at a rate of 5.0 percent and a monthly payment of $2151.
The fee-based loan has a lower payment by $120 per month. Since it cost $8,000, it would take 67 months to re-coup this cost with the monthly savings. This is called the break-even point.
If a customer plans on staying in the home longer than 67 months, the fee-based loan might be the best choice. In California, the average stay in a home is 4.2 years, therefore statistically; a no-cost loan might be the best loan. Another consideration is that with a no-cost loan, if interest rates were to drop during the break even period, another no-cost loan could be taken, which would further lower the rate, whereas it might be prohibitive to do another fee-based loan with an additional $8,000 in cost.
The best way to compare, is to get a written good-faith-estimate from a lender on each option showing the specific costs and interest rates and then ask the lender to calculate the break-even point based on those numbers.
No Cost Loans vs. Fee Based Loans by Kelly Bowlin is licensed under a Creative Commons Attribution-NonCommercial-NoDerivs 4.0 International
