The Truth About No-Cost Refinances

For the cash-strapped borrower, a no-cost refinance seems like a very attractive deal. And who would say otherwise when the lender pays for all closing fees? Per traditional mortgage calculation, closing can cost the borrower around 2 to 5 percent of the overall loan amount.

So if you’re taking out a home that is valued at $350,000 in the market, you would have to shell out $7,000 to $17,500 upfront in order to close the deal. Given that you still have to pay for the down payment amount, it’s no surprise why so many fall for the zero-cost promise of this mortgage program.

But here’s the truth: No Mortgage is Free.

When you opt for the no-cost refi option, the lender compensates for the cost in some other way.

No Cost Refinance Defined

A no-cost refinance does not differ from any traditional mortgage refinance transaction.

The only difference is that instead of the borrower paying for the costs of closing (appraisal, underwriting, credit check, inspection, attorney fee, etc.), the lender offers to shoulder the burden, costing the borrower no dollar out-of-pocket.

So what’s the catch?

In exchange for the missing dollars at closing, lenders will charge you with a higher interest rate.

So basically, while you pay nothing now, you still have to give the money back to the lender by paying for it throughout the life of the loan.

This arrangement is ideal for home buyers who want to take advantage of today’s historically low interest rates but don’t have the cash to seal the deal.

However, not all no-cost refis are created equal. Terms may vary from lender to lender. Pick the details of your loan term and identify which costs are covered and which ones are not. Sometimes, some lenders cover for only a portion of the fees and let you pay for the remaining charges.

Buyers have various reasons to refinance. Among the most common include:

1. Lower monthly payment by reducing the interest rate.
2. Pay off the mortgage early by reducing the loan term.
3. Reduce interest rate risk by converting from an adjustable rate to a fixed rate loan.
4. Keep options open for future interest rate fluctuations.

Among those who would benefit the most from this refi option are:

• All homeowners with a fixed term mortgage who have a rate of at least a 0.5% above the current market rate.
• All homeowners with an adjustable rate mortgage who want the security of a fixed rate or a medium term ARM rate.
• All homeowners with a fixed term mortgage who wish to switch to a different term.

When is it/not a good idea?

In a no-cost setting, paying up front usually saves the borrower more. Interest payments can total thousands over the life of the loan.

This being the case, a no-cost refinance only makes sense if you plan to refinance again in the next couple of years. This is because the slightly higher interest rate you will pay for within the first years of your mortgage will be less than the cost you need to shell out if you prefer to pay upfront.

Most traditional refis usually take five years to recoup refi costs paid upfront. If you stay in the house longer than this period, you might be paying more in the long run than if you chose to pay for the upfront costs – or a portion of it at closing.

You see, a no-cost refinance option can both be boon or bane depending on your current situation and your future plans. That is why as a home buyer, you should be able to honestly weigh in the risk and evaluate your finances before you make a move.