No-Closing Cost Refinance: Pros and Cons

One of the biggest drawbacks of a mortgage refinance is the many costs involved: lender fees, title insurance and closing costs. Homeowners who could reap a significant benefit from a mortgage refinance might be wary of the process because of the costs.

That’s where a no-closing cost refinance has some appeal, but it’s not without risk. Let’s explore this type of refinancing in more detail.  

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What is a no-closing cost refinance?

A no-closing cost refinance is a refinance without any upfront fees. Instead of paying out of pocket, your mortgage lender agrees to either roll the closing costs into your loan amount or increase your interest rate. As a result, your monthly payments are higher for the life of the loan.

Any time a lender pays closing costs, however, it’s not free money. To offset the costs, lenders typically do one of two things: charge a higher interest rate or add the fees to the principal loan amount.

Pros and cons of a no-cost refinance

There are benefits and drawbacks to a mortgage refinance with no closing costs. Here are some of the key ones to consider:

Pros

Save money immediately. When you pay closing costs on a refinance, it’s important to calculate your break-even point, or the amount of time it takes for the monthly savings you receive from refinancing to cover the cost of the refinance. For example, if a borrower stands to save $200 a month by refinancing and the new loan comes with $4,500 in closing costs, it would take nearly two years for the borrower to hit their break-even point. If they end up selling before then, though, they’ll lose money.

However, what if the borrower can save $100 a month by choosing a no-closing cost refinance? The savings are immediate because there is no break-even point to recoup closing costs. For those whose plans on how long they intend to stay in their home are still up in the air, a no-cost refinance can make a lot of sense. Use a mortgage refinance calculator to get a better picture if it makes financial sense for you.

Simplify mortgage shopping. If the costs are the same with different lenders ($0) and the loan type is the same, the main variable to focus on would be the interest rate. Two principles appear to operate in favor of those going after a no-cost refinance: simplified price shopping and the commitment from the lender that no cash charges will be added between commitment and closing.

Those who know they’ll be in their homes for many years may prefer a limited cash-out refinance. This variation of a rate-and-term refinance allows them to refinance into a new loan with better terms without emptying their wallets at the closing table. To accomplish this, the borrower must have sufficient equity because the new mortgage balance will be slightly larger to cover the closing costs.

Cons

Pay more money over the life of your loan. If a lender wraps closing fees into the loan, you’ll have a larger loan balance to repay. That means you’ll pay interest on the closing costs over the life of the loan. For example, financing $4,500 in closing costs at a 4% interest rate costs $7,734.13 over the life of a 30-year loan.

Make a higher monthly mortgage payment. A larger loan balance means a larger monthly payment amount. In the example above, adding the $4,500 closing costs to a $200,000 loan would increase the monthly principal and interest payment from $954.83 to $976.31 — a $21.48 difference that adds up to more than $250 each year. That might not seem like much, but it adds up over time.

How to save money on your refinance

Choosing a refi without closing costs is just one way to save money. Here are other avenues to cut down on mortgage refinance costs:

  • Build enough equity before you refinance. If you have private mortgage insurance (PMI) on your existing loan, you understand that’s an added monthly cost. Be sure you have at least 20% equity in your home by the time you’re ready to refinance so you no longer have to make PMI payments.
  • Shop around with multiple lenders. While you might be tempted to refinance with your current lender, take the time to shop around before you do. LendingTree’s Mortgage Rate Competition Index shows that refinance borrowers who shop around stand to save more than $58,000 in interest over the life of a 30-year, $300,000 loan by comparison shopping.
  • Make extra principal payments. Once you refinance your mortgage, consider making extra payments as often as possible to pay down the loan more quickly. One way to do this is by making biweekly payments. This strategy allows you to make one extra payment each year (13 months) and can cut down the amount of time it takes to pay off your mortgage by a few years. Another strategy is to pay a set amount each month on top of your mortgage payment.

The bottom line

So, is a no-closing cost refinance for you? In general, a no-cost refinance makes more sense when a borrower doesn’t have the reserves to pay closing costs or prefers to keep their savings intact. A refinance with no closing costs could also work for borrowers who plan to move within the next few years.

Your lender can help you address all the factors and make a financially sound decision.