No-Cost Refinancing Isn’t Free. Here’s How It Works

Photo illustration to accompany article on the true cost of no-closing-cost refinancing Getty Images

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With interest rates hovering around their lowest recorded levels, now can be a great time to refinance

Refinancing can help you lower your monthly payments, pay off your mortgage sooner, or even cash out your home’s equity to pay off higher-interest debt or make home improvements. 

But one thing you should be clear on: refinancing isn’t free.

Just like with a standard mortgage, you can’t refinance a mortgage without paying closing costs, which can easily be 2%-5% of the loan’s value. That’s thousands of dollars the average homeowner needs to refinance. 

Still, some lenders are known to market no-closing cost, or no-cost, refinancing. But the name doesn’t exactly mean what it says. The term “no closing cost” isn’t 100% correct, says Adam Spigelman, vice president of portfolio retention at the New Jersey-based Planet Home Lending

There are always third-party expenses on a loan, and while there are ways to roll those costs into your loan, that’s not the same thing as free. A no-cost mortgage isn’t eliminating the fees, it’s simply changing how you pay for them.

What Exactly Is a No-Closing-Cost Refinance?

Closing costs” is a blanket term for all the fees you’ll pay for a mortgage. This includes attorney, appraiser, inspector, lender and/or broker fees. No matter what type of mortgage you choose, there are always closing costs to pay. But for some of those costs, you can have a say in when and how they are paid.

A mortgage refinance marketed as no-cost can reduce your upfront out-of-pocket costs to nothing. But that simply means you’ll pay for closing costs in the loan itself.

Pro Tip

A no-closing-cost refinance doesn’t eliminate closing costs. It simply adds them to the loan, and can end up costing you more in the long run.

This is done in two ways: by adding the closing costs to your mortgage, or through a higher interest rate. 

If your closing costs are $6,000 and your mortgage is $200,000, you could refinance for $206,000 to build the extra costs into your new mortgage. In this scenario, your interest rate doesn’t increase, but you will have larger monthly payments because your principal is bigger. 

The other option is to accept a higher mortgage rate in exchange for a lender credit to cover closing costs. This will also increase your monthly payments compared to paying the closing costs upfront. 

When Does a No-Cost Refinance Make Sense?

A no-closing-cost refinance isn’t a free loan, but it can make sense depending on a variety of factors, like your current mortgage rate and how long you plan to stay in your home. The key question to ask yourself is: Will a no-closing-cost refinance improve your financial situation more than other refinance options?

Here are a few tips that will help you answer that question:

Calculate the Break-Even Point

At the end of the day, if you’re refinancing to save money, do the math for all of the options to see what makes the most sense. Nadia Alcide, mortgage loan professional with Mortgage Biz of Florida, recommends you sit down with your mortgage professional to calculate exactly when you will break even.

When you refinance a mortgage, look at the amount you’re saving on your monthly payment to calculate when those savings will make up for the closing costs. To do so, divide the upfront closing costs by the monthly savings–that’s the number of months you need to keep your refinanced mortgage before you break even and make it worthwhile.

You’ll ultimately save more money over time by paying closing costs up front rather than financing them. If you incorporate closing costs into the mortgage refinance, you’re paying the closing costs back each month, plus interest. If you roll $8,000 in closing costs into a 30-year loan at 3%, you’ll pay an extra $4,000 in interest over the life of the loan. 

Homeowners can also pay part of the closing costs up front, and include the balance in the new loan. Talk to your lender about how this can work.

Accepting a higher interest rate, instead of adding the closing costs to the loan, is typically only a good idea if you’ll be moving before the extra interest costs you more than what you would pay upfront. Just a 0.5% rate increase on a $200,000 30-year mortgage would cost an extra $20,000 in interest over the life of the loan.

Alcide recommends looking into not only lowering your rate with a refinance, but also shortening your term. If you switch from a 30-year loan to a 15-year loan you will likely have a higher monthly payment, but you’ll pay off your mortgage much more quickly. This is an excellent way to save on the overall interest you pay. 

You can use our mortgage calculator to compare the monthly payments and overall interest you’ll pay for each type of refinancing. You could also have a lender run the numbers for you, but, keep in mind, not every lender offers a no-closing-cost refinance option.

Look at Other Ways to Reduce Refinancing Costs

Just like when you got your initial mortgage, shop around for the best rates and compare fees. You should start your search with your current lender. A lot of times your current lender will offer good deals because it’s motivated to keep you, Spigelman says. For example, if you stick with your current lender, it may be willing to waive the appraisal, which saves you $300-$600.

While every lender charges closing costs, there is some flexibility with certain fees. Once you have a few offers in hand, you may be able to use competing offers to negotiate the rates and fees down. Be sure to ask about the purpose of each fee and whether or not it can be reduced or waived entirely.

Pay Attention to Your Home’s Equity

Rolling closing costs into a refinance will increase the loan principal, which will reduce your equity in the home. This might not be as big a deal if you have enough equity built up, but it can have consequences.

If your loan-to-value (LTV) is above 80% you’re required to pay for private mortgage insurance (PMI), on conventional loans. This insurance can cost up to 2% of your loan balance every year, which can add hundreds of dollars per month to your payments. So be sure to add PMI into the equation when comparing refinancing options.

The lender may also be willing to waive the appraisal fee if your home has enough equity. How much equity you need varies from 10-30% depending on the loan and type of refinance.