While home refinancing can provide tremendous advantages, borrowers should carefully consider their financial standing to determine whether or not securing a refinance loan for lower rates is worth the associated costs. Some refinances, however, do not include the standard costs involved in closing a loan. These transactions are known as no-cost refinances and allow borrowers to forego paying upfront closing costs in exchange for accepting higher mortgage rates.
What is a no-cost refinance?
Alternatively referred to as no-fee refinances, and no-cost mortgage refinances, no-cost refinances are refinance transactions with minimal closing costs. In the process of closing a traditional refinance mortgage, borrowers are subject to fees for title search, title insurance, courier fees, and even flood settlement costs. While these fees can exceed even a thousand dollars for typical refinances, no-cost mortgage refinances require that the lender pays the upfront expenses without the cost of enlarging the overall loan balance.
Despite the name, no-cost refinances typically include some costs which the lender will not cover. For instance, no-cost refinance lenders will not pay any fees associated with prepaid homeowners insurance, escrow charges, prepayment penalties levied through an old mortgage, or prepaid interest for the new loan. Prepaid interest solely applies to borrowers who close on a day other than the first of the month; these fees cover the interest which accrues between the closing date and the date of the first mortgage payment.
While no-cost refinances seem almost too good to be true, these refinance transactions include much higher interest rates.
Evaluating a No-Cost Refinance
Determining the worth of a no-cost refinance requires some evaluation of your circumstances. Generally, a no-cost refinance will greatly benefit homeowners who are planning for the short term. Eventually, the increased interest cost of the no-cost refinance will
accumulate to more than the initial upfront closing costs, in which case the refinance cost will have exceeded its worth. In the simplest terms, borrowers who pay off the loan before the cost of increased interest rates reaches the cost of the upfront closing fees will save money. Borrowers who pay off the loan after the break-even point will have paid more for the refinance than it was worth.
For a more exact calculation, consider the additional tax advantages of the higher interest rate, as well as how your savings will be affected by paying the upfront costs.
Despite the price, some borrowers may perform a no-cost refinance for other reasons. For instance, if the offered rate is still competitive and a borrower would prefer to invest his or her money elsewhere, the no-cost loan may be optimal for them.
Should I get a no-cost refinance?
In general, to determine whether or not a no-cost refinance would be beneficial under your circumstances, consider the following questions:
How long will I keep the property?
If you plan to move or upgrade to a larger or more expensive house, or if you plan on refinancing in the near future, a no-cost refinance could be beneficial. However, borrowers who plan to remain in the home for five or more years, depending on where the break-even point lies, should consider paying upfront to secure a better, long-term rate.
Can I afford the upfront costs?
While no-cost refinances can be a convenient way to pay less money and immediately, borrowers who pay the upfront closing costs and secure a lower mortgage rate will ultimately pay less. When possible, borrowers should opt to pay the upfront costs, unless they plan to move soon after the refinance.