It’s been said that there’s no such thing as a free lunch.
But if there are no closing costs in a “no closing costs” refinance, doesn’t that mean the loan is free?
Not quite. With a no closing cost refinance, you don’t pay closing costs up front when the loan closes. Instead, you can opt for a higher interest rate to cover these costs, or you can include them in your principal loan balance.
What's in this Article?
A no closing cost refinance is a loan option offered by some lenders in which you avoid paying upfront closing costs. Since closing costs can amount to several thousand dollars, a no closing cost mortgage refinance can be advantageous if you’d benefit from a refinance but do not have extra cash on hand.
J. Keith Baker, chair of curriculum for mortgage banking at Dallas College in Irving, Texas, explains that a no closing cost refinance is possible via one of two options.
“A mortgage lender can simply add the closing costs to the amount of your final loan balance,” says Baker. “Or, as a substitute for evading closing costs, you can pay an interest rate that is slightly higher than the current interest rate.”
Accepting a higher rate can be a tough pill to swallow, since you’ll pay more over the life of the loan. But that doesn’t mean it’s a bad choice.
“A no closing cost refinance can be a good way to go, but just know that nothing is truly no cost. If the lender is paying your closing costs on your behalf, you are getting a high rate. But this isn’t always a bad thing,” says Jodalee Tevault, a senior mortgage consultant with Fairway Independent Mortgage Corporation (Home.com’s parent company) in Chandler, Ariz.
She notes that as interest rates increase generally, a no closing cost refinance can be attractive.
“A great example would be someone who wants a cash-out loan now and rates aren’t as low as they have been, so they can get the cash-out without paying for it,” she says. “Then when rates improve, do another refinance for a lower rate. That way, they didn’t pay for two refinances but got the cash that they needed.”
When you refinance your mortgage loan, the closing costs can equate to approximately 2% to 5% of your principal balance, according to Baker.
Common closing costs on a refinance may include:
- Application fee
- Appraisal fee
- Discount points (1 point equals 1% of the loan amount)
- Upfront mortgage insurance fees if you choose an FHA or USDA loan
- VA funding fee if you are using a VA refinance loan
- Lender’s title search/review/insurance fees
- Lender’s title insurance policy
- Attorney’s fee
- Mortgage broker fee if you are working with a broker
- Underwriting fee
- Origination fee
- Recording fee
- Credit check fee
If you refinance your mortgage loan and your outstanding principal balance due is $300,000, your closing costs might range from $6,000 to $15,000 (2% to 5%). It can be challenging to come up with that amount of money in a lump sum due at closing. That’s why some borrowers opt for a no closing cost refinance.
Qualifications for a no closing cost refinance include:
- A qualifying credit score: Refinance guidelines may have higher credit score requirements than purchase loans. For instance, your lender may require a 640 minimum credit score on a conventional refinance loan, compared with the 620 requirement for purchasing a home
- Debt-to-income ratio (DTI): DTI requirements vary based on the type of loan you’re using, but expect the maximum DTI to be 36%-45%
- Sufficient home equity: Some refinance loans require you to have a certain amount of equity built up in the home. The minimum equity requirement is typically 20%. But some programs, such as the FHA Streamline, do not have equity requirements if your current mortgage is the same type of loan
Also, just like you had to do when you took out your first mortgage loan, you’ll need to provide documents and details about your employment and financial status. Be prepared to give the lender copies of your recent tax returns, recent pay stubs, employment history, W-2 and 1099 forms, and any other documentation they request.
As with any loan or financial product, a no closing cost refi has its advantages and disadvantages. Consider the following carefully.
|You don’t have to pay closing costs up front||Your monthly mortgage payment will be higher than if you’d paid the closing costs up front|
|Even if you choose the higher interest rate option, the rate could be lower than your current rate (otherwise you probably shouldn’t refinance unless getting cash out or changing your loan term)||You’ll pay more over the life of the loan|
|You can refinance to a lower rate in the future if rates improve again||Not all lenders offer no closing cost refinance loans|
There are many important factors to ponder before pulling the trigger on a refinance, especially a no closing cost refi.
What is the long-term benefit?
Lenders will not approve a refinance loan unless there is a clear benefit for the homeowner. Those benefits may include lowering your interest rate, reducing your monthly payment by extending your repayment timeline, getting rid of mortgage insurance, or taking cash out against your equity. Because you will pay closing costs one way or another, it’s important to ensure the benefits will outweigh those additional expenses
Can you reduce your interest rate, even if you do a no closing cost refinance?
Bruce Ailion, a real estate attorney and Realtor in Atlanta, says opting for a no closing cost refinance that involves a higher interest rate can be a smart strategy if you don’t have the savings to pay for closing expenses upfront.
“If done correctly, you will pay a slightly higher than market interest rate but a lower rate than you are currently paying, without increasing your mortgage balance. This rate should be lower than your current rate, so you have net savings,” says Ailion.
How long will you be in the home?
A refinance only makes sense if you plan to be in the house for the foreseeable future and you believe you can ultimately save money by either stabilizing your rate now or refinancing again to a lower rate in the future.
“It might be smarter to pay the closing costs upfront if you expect to stay put for the indefinite future and you anticipate interest rates will stay the same or go up,” says Ailion. “The advantage of the no cost refinance is that, if interest rates decline, you can refinance. If you expect interest rates to go up and you are planning on staying put long-term, paying upfront for a lower rate might make sense.”
Are you confident you are getting the best deal?
It’s crucial that you shop around carefully for the best no closing cost refinance offers from different lenders.
“Sometimes borrowers do not truly understand the costs that they choose to roll into their loan balance. They may not be aware that the closing costs are too high or that the loan rate is not as competitive as it should be,” Baker cautions.
Here’s a pro tip before you commit to a particular lender or loan program: Ask if they will waive or reduce any of the closing costs that are within their control.
No closing cost refinance FAQs
There are pros and cons to paying closing costs upfront. It will cost you more out of pocket at closing – usually several thousands of dollars – which can be financially challenging. But with a no closing cost refinance, you will either pay a higher interest rate or add the costs to your loan principal. And the larger your principal, the more interest you will pay over time.
Every borrower has to pay closing costs when they refinance. They can either pay this out-of-pocket in a lump sum at closing or, if their lender allows it, they can select a no closing cost refinance that involves paying a slightly higher interest rate or rolling the closing expenses into the principal balance.
Every time you refinance your mortgage loan, you will have to pay closing costs. While this can equate to 2% to 5% of your principal balance (usually several thousand dollars), a refinance can be worth it if you can lower your interest rate or reduce your monthly payment.
It can be. If you would benefit from refinancing but you don’t have the cash available to pay the closing costs up front, a no closing cost refinance may be the best option for you.
The important thing is to make sure that the long-term benefits of the no closing cost refinance are significant enough to warrant the higher interest rate or loan balance.
If you’re not sure what the right decision is, talk to a lender. They can review all of your options with you and show you how different loan programs will affect your finances.