Is A No-Closing-Cost Refinance Right For You?
Buying a home can be expensive. In addition to the purchase price, home buyers have to prepare for a variety of other expenses – like closing costs – when they complete the underwriting process and finalize the loan.
While it’s common to pay a single lump sum at closing, you can also finance your closing costs to reduce how much you pay upfront. The same can be done for a mortgage refinance. Let’s take a look at how a no-closing-cost refinance works and whether it’s the best option for you when you’re looking to refinance your current mortgage loan.
What Is A No-Closing-Cost Loan Refinance?
A no-closing-cost refinance allows you to avoid paying closing costs in a lump sum when closing on your new loan. It rolls them into your monthly mortgage payment or exchanges some of the upfront charges for a higher interest rate across the life of the loan.
To be clear, a no-closing-cost refinance does not mean your closing costs are completely forgiven or removed from the transaction. It means they’re dispersed across other areas of expense in your loan repayment plan. This type of refinancing could give you a larger principal and higher monthly payment, depending on how you choose to cover the closing costs.
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What Costs Are Typically Rolled Over?
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. Typically, the costs you’ll roll over when you opt for a no-closing-cost-refinance include lender fees, third-party fees, various homeowner fees and the cost of any mortgage points you want to purchase.
Lender fees will vary depending on your lender and the type of loan you have, but usually include:
- The loan origination fee (typically 1 – 5% of the loan amount)
- An application fee
- Prepaid interest on your first month’s mortgage payment
Your lender works with other service providers when you get a mortgage, and your closing costs will be used to cover these fees. Some third-party fees include:
- Appraisal fees
- Title insurance premiums
- Credit score report costs
As a homeowner, there are several costs you may be required to pay ahead of time, including property taxes and homeowners insurance. Payments on taxes and insurance are put into an escrow account. If your home is part of a homeowners association (HOA), fees may also be paid to them as part of your closing costs.
At closing, your lender might give you the option to pay for mortgage points, also known as discount points. This charge is paiddirectly to your lender to reduce your mortgage rate and monthly payment. Purchasing mortgage points is commonly referred to as “buying down the rate.”
How Does A No-Closing-Cost Refinance Work?
No-closing-cost refinances may be necessary for borrowers who don’t have the cash on hand required to pay fees at closing. If you’re concerned about paying a lot upfront when you close your refinance, you can choose to pay those fees over a period of time. The rolling closing costs can be spread across your loan repayment plan in a couple of ways.
Your Interest Rate Goes Up
If you don’t pay fees at closing, you likely won’t get the lowest interest rate possible. This happens because your lender will increase your refinance 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 interest rate that comes with them.
Your Loan Principal Increases
This option takes your closing costs and rolls them into your principal loan 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.
Unless you’re purchasing a home with an FHA loan, VA loan or USDA loan and building in certain fees, you can only choose to roll your closing costs into your principal with a refinance. Essentially, you would use your home equity to pay for the costs.
It’s important to note that not all lenders will offer both of these options for a no-closing-cost refinance. If you strongly prefer one method over the other, find out what the lender offers.
Who Benefits Most From A No-Closing-Cost Refinance?
If you’re planning to sell your home and move within 5 years, or if you think you’ll refinance soon, it might be wise to consider a no-closing-cost refinance. Typically, taking a higher interest rate will cover the amount you owe in closing costs within 5 years. You’ll avoid paying the closing fees as a lump sum upfront, and you won’t be in the home for a long enough period to pay significantly more in interest.
This option might also make sense for homeowners who are looking to renovate their homes but don’t have the cash for it. For them, taking a higher interest rate to avoid closing fees might be less costly than taking out a home equity loan. Borrowers can use a cash-out refinance and avoid closing costs while getting a new mortgage.
Homeowners with an adjustable-rate loan can use a no-closing-cost refinance as well to change to a fixed-rate mortgage. If your interest rate is about to start changing, but you don’t have enough savings to cover the cost of the refinance, this could be the right option.
Typically, if you plan on living in your home for more than 5 years, the extra interest you pay may eventually exceed the amount you would have paid in upfront closing costs. That means you might end up paying more than you would have if you’d put up the money in full at closing. How much more depends on your specific loan terms.
Understanding Refinance Fees
When you apply for a refinance, your mortgage lender can provide you with a detailed analysis of your closing costs along with the difference in your interest rate depending on whether you pay them as an upfront fee or over time. Knowing these numbers lets you see how much more you would 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’ll end up paying around $16,000 more over a 30-year period than you would if you’d paid the closing costs upfront.
This information will help you determine the breakeven point – the point where paying the closing costs upfront makes more sense than paying higher interest. Alongside your budget, evaluate refinancing costs to determine the best course of action to hold onto your house without breaking the bank.
The Bottom Line: A Refinance Without Closing Costs Can Be The Right Choice
Financing closing costs over a longer period 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! Start your application online today and talk to one of our Home Loan Experts to learn more. You can also give us a call at (833) 326-6018.