What Does a ‘No-Cost Refi’ Really Mean?

The pitch for a no-cost refinance sounds pretty attractive: replace your current mortgage with a lower-interest rate mortgage and pay nothing for the privilege of doing it. But before signing on the dotted line, it’s important to realize that “no cost” doesn’t typically mean “free” when it comes to refinancing.

The true meaning of “no cost”

No-cost refis usually mean that borrowers won’t pay upfront costs to get the new mortgage loan — so they might better be called “no-initial-out-of-pocket-cost refis” — but that doesn’t mean the loan won’t cost in the long run. In general, there are two ways a lender can offer a no-cost refinance:

  1. ) The lender waives the closing costs but will charge a higher interest rate on the loan in exchange;
  2. The lender rolls the closing costs into the total loan amount, and the total amount of the closing costs becomes part of the principal owed to the lender.  Of course, sometimes no-cost refis really come at no cost because borrowers don’t pay higher interest rates or get closing costs rolled into their loans, but this tends to be the exception, not the rule.

Pros and cons of a no-cost refi

The biggest benefit to a no-cost refi is that borrowers won’t have to pay upfront costs to get new loans.   Because closing costs average roughly $3,700, this can mean a big initial savings.

Borrowers typically pay for this initial savings in the long run. If borrowers paid higher interest rates in exchange for paying no closing costs, they may pay far more for their mortgages over the life of the loans. Consider a $200,000 loan for 3.75 percent if the borrower pays closing costs or the same size loan for 4.1 percent if the borrower does not pay any closing cost upfront.  Over a30-year term with a3.75percent interest rate, the borrower would pay roughly $133,000 in interest.A borrower with a4.1percent loan, would pay roughly $148,000 in interest.The difference is far more than the $4,000 of closing costs. If closing costs are wrapped into the principal, borrowers may also pay more over the life of the loan because they owe interest payments on the loan amount and closing costs.

Is a no-cost refi right for you?
Refinancing, whether it’s no-cost or with closing costs, may make sense for people who want to: lower their interest rate, which means they pay less money over the life of the loan; lower their monthly payments, which can free up more cash to pay bills; and shorten the term of the loan, which likely means higher monthly payments, but that the borrower pays far less to the bank in interest over the life of the loan.  Often though, borrowers pay a price (closing costs) to refinance, so they need to make sure that they’ll end up saving money by refinancing. Typically, paying closing costs upfront makes more sense for people who plan to stay in the home for longer than five years, because paying these costs upfront tends to save money in the long run.

If borrowers don’t have the money for closing costs but want to get in on the low interest rates being offered right now, a no-cost refi might be a good option. Evaluate mortgage payments at their lower costs using Zillow’s mortgage calculator. In general, a no-closing cost refinance may make sense for borrowers who don’t plan to stay in their homes for longer than five years, even if the interest rates are slightly higher. The no-cost refi option still may be cheaper in the short-term than paying the upfront closing costs. However, borrowers have to do the math. To figure out if a no-cost refi makes financial sense, ask the lender to do a side-by-side comparison of the total cost of the loan (principal and interest) and monthly payments with closing costs upfront verses rolled into the loan.

Caveats
Rates and terms for no-cost refis vary, so get quotes from at least three lenders before deciding which one to go with. Note that even no-cost refis might include upfront costs.  For example, most lenders only guarantee the interest rate for 45 or60 days; if the loan takes longer to process than 45 – 60 days, borrowers may have to pay a fee to get that interest rate re-extended.  Finally, beware of the fact that some lenders who offer refis have instilled a prepayment penalty, which forces borrowers to pay fees if they prepay some part of the loan within a specified amount of time (often five years). Before agreeing to the loan terms, ask the lender to explain all fees and penalties.

This article was written by Catey Hill on behalf of Zillow.

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9 thoughts on “What Does a ‘No-Cost Refi’ Really Mean?

  • Something many people forget when considering a refi is that the clock starts over on your loan. Of course you’ll be paying less per month. You’ve put 10 years into a 30 year loan and paid off a chunk of the principal, and now you’re just refinancing what’s left of the principal and tacking on another 10 years of payments.

    If a refinance is actually good for you, it means you can pay extra on the principal and pay off the loan in the same amount of time for less money–or else, you’re choosing a shorter term loan in the first place. The apparent savings of a lot of refinances disappear when you add on more years of payment!

  • We refinanced about 18 months ago, and we chose to have a lower rate with closing costs, but we rolled the closing costs into the loan. The payback period of doing so was about 7 months before our balance was lower than what it would have been had we continued paying on the old note, so that was fine for us.

  • I agree with Money Beagle. I think a no-cost refi can work out if you roll the closing fees back into the loan as long as you plan to be in the house for however long it will take the monthly payments savings to offset the closing fees. Granted, you should add in the interest you are now paying on top of those closing costs. I have refi’d twice since being in this house and we lowered our payment a total of $700. We probably still have a little ways to go before we would technically pay the closing costs off. But I do not see us going any where in the short term.

  • This is a great article. We were looking to refinance our rental property lately and we ran into the very same deceptive wording that you describe. Luckily we were able to find an actual no-cost streamline refinance. We dropped our interest rate 1.5% and didn’t increase our principal balance!

    • That’s pretty good, especially with rentals. I’m not in love with the rate that I am paying for my rental (5.25%) but I honestly paid nothing but a $125 loan origination fee. 🙂

  • I am actually doing a refi now. I faulted on my loan a year ago and had to wait to do the refi. I just paid my May’s and my mortgage guy said we were a go. I can’t wait.

  • These always sound so good, then I read the fine print and wonder if it really is a good idea. My current rate is around 5.25 so unless I can get something in the mid-4 range it won’t help much. And since you pay a higher rate on no cost refi’s I usually can’t find one. Oh well.

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