Nothing in life is free, and mortgages are no exception. A major drawback of doing a mortgage refinance is you have to pay closing costs and fees. Add them all up, and you are talking several thousand dollars. Homeowners typically love no cost refinancing as long as there are truly no lending fees.
These costs usually include things such as:
- Application fee
- Credit report fee
- Loan origination fees
- Administrative fees
- Appraisal fees
- Title fees
Even if you are sure that refinancing will save you each month, what if you cannot afford the costs of refinancing? The no cost mortgage refinance could be an option, but what does it entail in terms of the costs over the long term? Below is more information about a no closing cost refinance loan.
Overview of the No Cost Refinance Mortgage Program
A no cost refinance can have several different meanings. Most commonly, it means you are getting a loan with no lender fees, no closing costs, no lender fees and no closing costs, and no out of pocket costs at all.
This type of loan involves the mortgage lender paying for some or all the loan costs. Thus, the money is coming from somewhere else in the financial transaction. There is no free lunch. Typically, the lender will charge you a higher interest rate for them to pay the costs of the loan. In many cases, this makes sense, because many borrowers would rather pay .125 or .25 higher on their interest rate then to come up with $3,000 to $5,000 up-front to pay for the standard lending costs. This allows them to get more interest payments over the loan term, or to sell the loan to investors at a steeper price. But if you get a loan with no ‘out of pocket costs’, you probably are having the closing costs wrapped into the loan.
Whether you are pay a higher interest rate or have a higher loan balance to have no closing costs and fees, know that you are paying in the end. It is just that you are not having fork over cash at the closing table.
Advantages of the Home Refinancing with No Costs or Fees
Closing costs on a loan can easily run $3,000, $5,000 or more, depending upon the state and size of the loan. The major advantage of the no cost refinance is you may be able to enjoy a lower rate (and possibly getting cash back from your equity) without having to pay anything out of pocket. This can be a very tempting possibility for people who do not have a lot of cash available.
For example, with today’s low rates, you may be able to save $300 per month off your mortgage cost, but what if you have to pay closing costs of $4,000? It would take you at least 18 months to break even on that out of pocket cost. But, if you can save $300 per month and have no out of pocket costs with a no cost refinance, you are enjoying a financial benefit right away. The savings are right away because you did not have to pay anything. Besides, most homeowners will refinance within the first two years of their mortgage any way. Suddenly the cost refinance is making a lot of sense.
Another advantage of a no cost refinance is it makes shopping for a new loan easier. It can be challenging to compare different loans with closing costs because those costs can vary a lot from lender to lender. If you have zero closing costs, all you must look at is the interest rate. In fact, a 2008 study found borrowers were more effective in getting a lower interest rate when they shopped for a no cost refinance.
If you are going to stay in your home for years, you may want to particularly consider the no out of pocket cost option. This means you may be able to buy down the rate to get a lower payment without paying out of pocket at closing. This will only work if you have enough equity because your new balance will be bigger.
Disadvantages of a No Cost Refinance
As we said before, there is no free lunch in life. If the closing costs are wrapped into the loan, you mortgage balance and payment is larger. You will be paying interest on those closing costs for the entire term of the loan. If you pay for closing costs by paying a higher rate, you will be paying interest with the higher rate for many years.
Whether or not this is worth it depends upon your financial situation. If you do not have the means to pay for closing costs, and this means you will not be able to refinance into a lower rate, going with no cost refinance options may be the logical choice
The no closing cost or no cost refinance option will usually cost you more in the long run, but it is sometimes a good idea. If you are not going to stay in the home for more than a few years, doing this type of refinance could be a smart move. But if you are staying in the home for 10 or 20 years, know you are paying on a higher loan balance, or are paying a higher mortgage rate, for that entire loan term.