Do Lenders Offer Grants to Cover Settlement Costs?

March 20, 2000, Revised November 29, 2006

"I was told that a certain mortgage lender offering loans on the internet provided grants to first-time home buyers. The grants cover all settlement costs. Is this for real?"

No. I went to the web site you mentioned, and found a mortgage broker offering "no-cost" loans. There are hundreds of others doing the same, off and on the web. But there is no grant involved, and you don't have to be a first-time home-buyer to get one.

College freshman learn in Economics 101 "There is no such thing as a free lunch." Similarly, in the home loan market, there is no such thing as a no-cost mortgage. The borrower always pays the settlement costs -- one way or another. If they don't pay it in cash at the closing, they pay it in the future by accepting a larger loan amount or a higher interest rate.

In the second and more common case, mortgage brokers offering no-cost mortgages collect from the lender a fee called a "yield spread premium" (YSP) on a high-interest rate loan. The broker pays your settlement costs out of this fee, and has enough left over to compensate himself. Lenders dealing directly with borrowers do the same thing, except that there is no YSP. In effect, they pay the fee to themselves and there is no record of it.

Although no-cost mortgages are not a free lunch, they do have advantages for some borrowers, especially those who expect to be in their house only a few years. For a more detailed analysis, read No-Cost Mortgages.

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