No Cost Refinance

by David Sandberg

Closing a loan is an expensive process. Even the simplest refinances can carry thousands of dollars in costs for such things as interest payments, appraisals, title insurance, document fees, origination fees, closing fees, and myriad other things. However, many people are able to refinance their homes without actually paying those costs.

There are two types of no-cost refinance. The first one is a refinance where the closing costs get borrowed. The second is one where the interest rate gets raised slightly to compensate for the closing costs. Both types of loans can make sense in different situations

Refinance with Costs Folded In

While this loan is not truly a no-cost refinance, it has the same effect in that it does not require you to spend any out-of-pocket money. The way that it works is that the lender or mortgage broker collects a deposit from you, uses some of that deposit to pay the costs of obtaining the loan, then increases size of the new mortgage to write three checks — one to your old lender to pay off the mortgage and two small checks to you and to the new lender to reimburse them for costs incurred.

For example, consider a borrower who took out $200,000 7 years ago at 6.5 percent and now owes $180,832.00. Their payment is $1,264.14 per month for principal and interest. Looking to save money, they contact a lender who finds them a new interest rate of 4.01 percent and closing costs of $6,500. This leads to an $187,332 mortgage with a monthly payment of $895.43, saving them $368.71 per month.

Refinance with No Costs

Many people consider a true no-cost refinance to be the best option. In this loan, the lender charges a higher interest rate and absorbs all of the costs of making the loan. With the higher interest rate, they can either earn more money over the life of the loan to compensate them or they can sell the loan at a higher price and get their money back.

Taking the same example of the above couple, they go to a different lender who offers to refinance their $180,832 balance at a 4.35 percent rate with no costs. This gives them a monthly payment of $900.20, saving them $363.94 a month.

Which is Better?

In the above scenario, financing closing costs looks like the better deal since the first loan’s monthly payment was $4.77 less. However, this does not take the whole situation into account. Financing closing costs increases the amount of money that you owe on your home which is undesirable and can make selling the home or refinancing in the future more challenging.

Also, if the second loan carried an interest rate of 4.30 percent instead of 4.35 percent, it would have actually been a little bit cheaper. It is hard to predict which type of no-cost refinance will be less expensive, since it depends on the amount of closing costs and the difference in interest rates between the two loans. The only way to be sure is to compare two loans and find out which is best with you.

The Unspoken Problem with No-Cost Refinance Loans

Lenders rarely discuss the downside to refinancing a mortgage loan — you will end up spending a longer period of time to pay off your home. It will take you a total of 37 years to pay off your loan if you take out a 30-year refinance after 7 years. An excellent way to mitigate this is to refinance into a shorter-term loan like a 10 year mortgage or a 15-, 20- or 25-year amortization mortgage. While these mortgages carry higher payments, they can lead to you owning your home free-and-clear more quickly.

However you choose to refinance your home, taking out a no-cost refinance makes a great deal of sense. Doing it this way can not only save you money every month but also save the lump sum of money that you would have used on closing costs. You can then use that money to invest elsewhere, pay off other debt, or improve your home and add value to it.

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