No-Closing-Cost Refinance: Is It Right for You?

Managing Your Mortgage, Mortgages
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no closing cost refinance

A no-closing-cost mortgage may sound too good to be true. But if refinance rates are favorably low — yet scraping together the upfront fees is discouraging you from refinancing your mortgage — a no-closing-cost refinance may be worth considering. Especially if you’re planning to stay in your house for only a few more years.

How a no-closing-cost refinance works

Closing costs can amount to 3% to 6% of your principal balance, according to the Federal Reserve Board. These are the charges for an appraisal, title search, recording fees and all the rest. But lenders will often package “no-closing-cost” mortgages for qualified borrowers. This can be achieved in a couple of ways.

Charging a higher interest rate. The lender may cover the expense of a refinance with no closing costs by raising the interest rate on the loan. That way the lender will make it all back, and possibly much more over time, while enticing more loan business to its mortgage department.

Wrapping the fees into the financing. Or, the lender may roll the “no-cost” refinance fees into the total principal balance you’ll owe. It’s a different method with the same result: a higher payment, as the fees plus interest are paid over the life of the loan.

Pros and cons of a no-closing-cost refinance

Pros:

  • No upfront fees paid at closing
  • Not paying big upfront fees means a shorter break-even point
  • Paying zero fees makes it easier to compare interest rates among lenders

Cons:

  • You’ll owe a higher monthly payment
  • You’ll likely pay more interest over the life of the loan

When to choose a no-closing-cost refinance

Hoping to move up to another house fairly soon? The no-closing-cost mortgage refinance may be for you. If you plan on staying in a home for just a couple of years, you probably couldn’t recoup in refinance savings the upfront fees you’d pay anyway.

And it’s the only option — other than waiting to buy — for those who simply don’t have the savings to cover the upfront closing costs.

The downside of a no-closing-cost refinance

If you’re putting down roots for a longer period of time, you probably should consider paying the closing costs upfront. It’s just a matter of a doing a little math.

While your upfront costs are reduced with a no-closing-cost refinance, the result is a higher payment and perhaps significantly more interest that will be paid over the life of the loan. Lenders may also add a prepayment penalty provision to the loan in order to discourage you from refinancing again before they’ve recouped their costs.

Running the numbers

In order to make a wise decision, ask the lenders you are considering to provide an analysis of the closing costs, as well as the difference in interest rate and payments for a no-closing-cost refinance compared with a loan with upfront fees. With an application, each lender will supply an official Loan Estimate detailing the costs and terms they’re offering.

Now you can compute the “break-even” point for how long it would take to recover the closing costs on a loan and compare that against the no-closing-cost mortgage. Let’s say your closing costs on a loan would total $3,500. Here’s how to calculate your break-even period:

How to calculate your break-even point

Compute the monthly savings from your existing house payment versus your new, lower refinanced monthly payment. We’ll use a $150 savings as an example. (Example: $1,200 – $1,050 = $150 monthly savings)
Subtract your effective tax rate from 1. We’ll use a 25% tax bracket. (Example: 1 – 0.25 = 0.75)
Multiply your monthly savings by your after-tax rate. This will be your after-tax savings. ($150 x 0.75 = $113)
Divide the estimated closing costs by your after-tax savings to get number of months to break even. ($3,500 / $113 = 31 months)

In this example, it would take 31 months to recoup the closing costs for a standard refinance. If you plan to stay in your home for at least three years, you would be able to recover the upfront fees of your refinance.

Now you can compare that with the increased interest rate and payment of the no-closing-cost refinance, while considering how long you intend to remain in the home.

Want us to do the math for you? Using the NerdWallet refinance calculator, input the terms of the refinance with no closing costs, and then the terms of the standard refinance with upfront fees. The calculator will show your break-even points, as well as monthly payment and savings.

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Updated Aug. 3, 2017.