Refinance Without Closing Costs
While it’s common to pay a single lump sum at closing, you can also finance your closing costs to reduce how much you have to pay upfront. Let’s take a look at how this works and whether it’s the best option for you.
What Are Closing Costs?
Closing costs are a collection of expenses that come with purchasing or refinancing a home. These costs are separate from the home’s purchase price and may include the following:
- Lender fees: Your lender collects fees for creating the loan and processing your application. These fees will vary depending on your lender and the type of you loan you have. You’ll also prepay interest on your first month’s mortgage payment.
- Third-party fees: Your lender works with other companies when you get a mortgage, like an appraiser, a title company and credit services. Your closing costs will be used to cover these fees.
- Homeowner fees: As a homeowner, there are several costs you may be required to pay, including property taxes and homeowners insurance. Payments on taxes and insurances are put into an escrow account. If your home is part of a homeowners association, fees may also be paid to them as part of your closing costs.
- Mortgage points: At closing, your lender might give you the option to pay mortgage points, also known as discount points. This is a fee that you pay directly to your lender to reduce your interest rate and monthly payment. Purchasing mortgage points is commonly referred to as “buying down the rate.”
Mortgage Points Explained
When you pay one mortgage point, it means that you pay 1% of the loan amount. For example, if your loan amount is $200,000, one mortgage point equals $2,000. Typically, for every point you purchase, your lender reduces your interest rate by 0.25%. However, this can change. The actual impact of a mortgage point varies by lender, loan type and current mortgage rates.
Additionally, “paying points” doesn’t always mean paying whole points. Let’s say your lender allowed you to buy half of a mortgage point. On a $200,000 loan, that would cost $1,000 and typically reduce your interest rate by 0.125%.
Whether or not mortgage points are worth purchasing depends on your break-even point. This is the point at which the savings you generate from the points covers the amount you paid for them.
How a No-Closing-Cost Refinance Works
If you’re concerned about bringing a lot of cash to the table to close your refinance, you can pay those fees over time, rather than upfront in a single lump sum. For some borrowers, this option may be necessary if they don’t have the cash on hand required to pay fees at closing. This can be done in a couple ways.
Your Interest Rate Goes Up
If you don’t pay fees at closing, you won’t get the lowest interest rate possible. This is because your lender will increase your rate to recoup the amount you owe in closing costs. Additionally, if you choose not to purchase mortgage points, you miss out on receiving the lower rate that comes with them.
The Fees Roll Into Your Principal
This option takes your closing costs and rolls them into your principal balance. In other words, they’re added to the amount you borrowed from your lender and factored into your monthly payment. While this doesn’t affect your interest rate, you’ll pay more interest over the life of your loan since this increases the overall amount borrowed.
Keep in mind: unless you’re purchasing a home with a VA or USDA loan, you can only choose this option with a refinance. Essentially, you would use your equity to pay for the costs.
When It Makes Sense to Pay Closing Costs Upfront – And When It Doesn’t
If you’re planning to sell your home and move within 5 years, or you think you’ll refinance again soon, consider a no-closing-cost refinance. Typically, taking a slightly higher interest rate will cover the amount you owe in closing costs within 5 years. You’ll avoid paying the closing costs as a lump sum upfront, and you won’t be in the home for a long enough period of time to pay significantly more in interest.
This option might also make sense for homeowners looking to renovate their home, but who don’t have the cash for it. Taking a higher interest rate to avoid closing fees might be less costly than taking out a home equity loan.
Typically, if you plan on staying put beyond 5 years, the extra interest you pay may eventually exceed the amount you would have paid in closing costs upfront. Bottom line: you might end up paying more than you would have if you paid them at closing. How much more depends on your loan terms.
Know the Numbers
When you apply for a refinance, the lender can provide you with a detailed analysis of your closing costs along with the difference in your interest rate whether you pay closing costs upfront or over time. Knowing these numbers lets you see how much more you pay over the life of your loan with a no-closing-cost refinance option.
For example, let’s say you have $150,000 left to pay on your loan when you refinance. The lender offers you a 3.75% interest rate and requires you to pay $3,500 in upfront closing costs. You have the option to finance the cost into your mortgage by paying a higher interest rate of 4.25%. If you take this option, you would end up paying around $15,000 more over a 30-year period than you would if you paid the closing costs upfront.
This information will help you determine the “break-even” point, or the point where paying the closing costs up-front makes more sense than paying higher interest.
The Bottom Line
All in all, financing closing costs or paying them upfront each have their own benefits and drawbacks. Knowing what you’re comfortable paying upfront and what your long-term goals are can help you decide which option is best for you.
When you’re ready to explore refinancing options, we’re here to help! You can get started by applying online with Rocket Mortgage® by Quicken Loans®. If you’d rather get started on the phone, our Home Loan Experts are ready to help you out at (800) 785-4788.