The Real Cost of Free

You have probably heard of the popular saying that “there is no free lunch.”  Therefore, when you are offered a service or a product for free we are all conditioned to look for a “catch” of some kind. Well the real estate and mortgage industries are no exceptions in this regard. How many times have you heard a mortgage company say—-refinance at “no cost”?  Or a real estate agent may advertise listing services at “one low fee”? 

Well, we all know that there is no free lunch. There are no “free” refinances. And as far as the “one low fee” listings—you get what you pay for. 

There are closing costs associated with both purchasing a home and/or obtaining a mortgage. With regard to mortgage costs, you may pay taxes, appraisal and credit report fees, fees charged by the mortgage company, fees charged by the settlement company and more. On a $300,000 mortgage, the costs may be in the range of $3,000 to $6,000 and even higher for someone with poor credit. So how can you get by with not paying these costs?

Simply, the mortgage company can charge you a higher rate and recover the costs in the secondary market after the loan is sold. Explaining the process of selling the mortgage is not important at this juncture. However, explaining the choices given to consumers is very important. 

A consumer can opt for a rate of 3.5% and pay $5,000 in costs or the consumer can opt for a rate of 4.50% and pay no costs. One is not a better deal than the other as the mortgage company may generate the same revenue in each situation. Note that the rates are fictitious for comparison purposes only.

So which is better for the consumer? Simply it is a matter of time. In this case we must make some very simplistic assumptions—

• The present value of money is the same as the future value of money. High levels of inflation can actually make money paid in the future less expensive than money paid today.
• The consumer can afford to pay the costs and can qualify at any rate (they have the choice). Many consumers do not have cash or equity in their home to pay these costs or need a lower rate to help them qualify. 

Looking past these assumptions as well as the fact that some of the costs as well as the payment can be tax deductible, if the consumer uses the mortgage for a long time. They may be better off with the lower rate and higher fees. If they pay $5,000 in fees and also pay $200 less monthly. They will recover the cost of the fees within 25 months, or two years. If they are going to purchase another home or refinance in less than two years, they are better off not paying any fees and going with the higher rate. If they don’t purchase or refinance for ten years, they are better off paying the higher fees.
  
It is important to note that I’m not advocating a “no cost” mortgage or a “high fee” mortgage. Every mortgage has a cost and you must look at the individual situation to see what is right for you. The decision may hinge upon many factors, including time, tax brackets, cash reserves and more. There may be no free lunch, but it is good to have choices. 

The same concept applies to real estate. When someone is offered the service at a flat fee instead of a percentage of the sales price you must ask, where is that agent making their money? There is no free lunch. But that is a topic for a future discussion.