Q: I hear ads offering "no closing costs" from some lenders, while others indicate that closing expense may be as high as 3% of the loan amount. That’s a big difference. How can that be?

A: Because there are actual hard dollar expenditures associated with the settlement of a home loan in Georgia, it is not possible for anyone to close a home loan for free.

However, it is possible that a lender could be induced to pay all those costs for you, provided you agree to accept a higher interest rate on the loan.

Remember that the loan is, in most cases, packaged and sold to an investor, who pays the originating lender based solely on the yield of the loan. The higher the yield, the more the investor will pay for the loan.

Q: So, how much of an interest rate premium must I pay in order to make it worthwhile for the lender to pay my settlement costs?

Because some of the costs of closing are fixed while others vary with the amount of the loan, the interest rate premium is slightly higher on low dollar loans and is slightly lower on high dollar loans.

For example, on a loan of $150,000, you could likely find a lender willing to pay all your closing costs in exchange for a premium of 75 basis points. That translates into a three-quarters percent addition to the typical fixed rate loan.

In contrast, on a loan of $300,000, you could probably find a lender who would waive closing fees in exchange for a premium of about 40 basis points. Each basis point is equal to 1/100th of an interest rate percentage point.

Q: What are the major fixed and variable costs of a real estate closing?

A: The appraisal, credit report, title search, attorney’s fee, and recording fees are all largely fixed.

However, the lender’s origination fee, the Georgia intangibles tax, and the title insurance costs vary with the total amount being borrowed.

Typically, on a loan of $150,000, the actual total of closing expenses charged to the borrower would be about three percent of the loan amount. On a loan of $300,000, that percentage might drop to two percent of the loan, or even slightly less.

Q: How can the buyer decide between paying or not paying closing costs?

A: By performing a cost-benefit analysis.

First, calculate the dollar amount of settlement costs being saved under the "zero cost" option. Then compare that to the additional annual interest expense you will experience with the higher interest rate. If you avoid paying $3,000 in closing costs, and it costs you an additional $1,000 in annual interest expense, then your break-even period is three years.

If you sell or refinance within three years, you will have saved money. However, if you continue to pay the higher interest rate beyond the three year break-even date, you will have lost money.

Q: When is it beneficial to seek a "zero closing cost" loan?

A: Such a loan makes sense when you believe that you will be keeping the loan for a relatively short period of time. For example, if you thought there was a good chance you would be leaving town in a couple of years, you might be better off with a "zero closing cost" product.

On the other hand, if it is likely that you will continue to own the house for a number of years, you will be much better off with the lower interest rate. You will be rewarded each and every month after you have reached break-even.

Q: Which lenders offer the "zero closing cost" option?

A: Almost any lender can choose to offer the option of paying your closing costs in exchange for a slightly higher interest rate. Some prefer to avoid trading an interest rate premium for settlement costs, while others make a big deal about it in their advertising.

These "zero closing cost" loans are most popular with lenders who specialize in refinance loans, because they theoretically make it worthwhile for a borrower to refinance when achieving only minor rate reductions.

For example, let’s say you plan to stay in your home no more than one year. If your current home loan carries an interest rate of 7.0%, and you were offered the opportunity to refinance with no out-of-pocket expenses at an interest rate of 6.75%, you should probably proceed with the refinance.

Even though the rate reduction is only one quarter of a percent, it cost you nothing and rewards you every month. Such a refinance would make more sense than a traditional "full closing cost" loan, because the costs of closing would exceed your monthly savings in the coming year.

Q: What is the best way to shop for a "zero closing cost" loan?

A: Find several reputable lenders who are willing to offer the option you want. Then ask each to fax you a good faith estimate of settlement costs showing loan amount, interest rate, and total out of pocket costs to you. Only then can you know that you have found the best loan for your particular situation.