No mortgage is free. There are always fees and closing costs associated with a refinance mortgage loan, the question is, who is paying for the refinance closing costs and fees? In most cases, all the costs total thousands of dollars. Unless you are okay with paying those costs by opening your checkbook at the closing table, there are other options to pay them when you refinance your mortgage: Just add them onto the amount of the loan. This is known as a no closing cost refinance mortgage, or a no cost refinance.
This sounds great, right, but what’s the catch? In most cases, you must take a slightly higher interest rate for the life of the loan for the opportunity for no closing costs or fees with the new loan. For example, based on the 1-15 Freddie Mac Weekly Rate Survey, you could have a mortgage at 3.75% and pay for your closing costs and fees at closing. Or, you can do a no closing cost refinance and pay a rate of 4.125%.
When Does a No Closing Cost Refinance Mortgage Pay Off?
Closing costs include fees such as loan origination fees, appraisal, title search and title insurance. These costs vary considerably by each state. But generally, closing costs for loans are on the rise as the housing market is heating up. Bankrate’s 2017 closing costs survey found that the origination and third-party fees on $200,000 mortgage averaged $2,084. For more expensive homes, the closing costs will of course be higher.
The no-closing cost mortgage products are nice for the homeowner who either does not have or does not want to pay the cash up front to redo the loan. Perhaps the interest rate on the new loan is a lot lower than what you pay now, and you really want to pull the trigger on the refinance, but don’t have the cash to pay the closing costs. Including the closing costs in the new mortgage might be the way to lower your payment.
Also, if you do not plan to stay in the house for more than a few years, a no closing cost loan can make a lot of sense. With a regular mortgage, it can take more than five years to recoup your closing costs. Your slightly higher interest rate with a no closing cost refinance is probably going to be less expensive over five years than what you would have paid in closing costs up front.
Experts say it is important to look at the break even point. For example, if you had a mortgage loan at 6% and just want to stay in the home for four more years, you could be a good candidate for a no closing cost refinance mortgage. Paying the higher rate also can make sense if you want the cash to do home renovations.
Another possible benefit of no closing cost mortgages: It makes it easier to shop for a mortgage. You know that the closing costs are the same for each loan: zero. So, you really only need to focus on the interest rate. A HUD study in 2008 found that homeowners were better able to negotiate the rate when they shopped in this fashion. No closing costs to haggle over clears away any confusion and allows you to just focus on the interest rate.
When Does a No Closing Cost Refinance Not Pay Off?
Are you going to stay in your home for more than five years/ If so, your no closing cost loan will cost you more than the refinance with closing costs? In most cases, you will break even on closing costs in three to five years. Getting a no closing cost loan for the long term will saddle you with a higher rate over many years. This could cost you much more than the upfront closing costs and fees you would have paid with a regular mortgage.
For example, let’s say you have two options for a refinance of $150,000. One loan has a 3.75% rate and $3,500 in closing costs. The other loan has a 4.25% rate and no closing costs. With the higher rate, the no closing cost loan will cost you $43.00 per month more. This adds up to $15,500 more over 30 years. In this case, it will take 6.5 years to break even and recoup the $3500 in closing costs.
Takeaways on the No Cost Refinance Mortgage
Refinancing your mortgage with no closing costs largely comes down to an analysis of your personal financial situation, as well as your living situation. Do you have the cash available to easily pay the closing costs? Then you might want to go ahead and pay them. But if you think that you may only stay in the home for a few more years, a no closing cost mortgage can make sense.
References: Is No Closing Cost Mortgage for You? (2017). Retrieved from https://www.bankrate.com/finance/mortgages/is-no-closing-cost-mortgage-for-you.aspx