A no-closing-cost refinance sounds divine, but it’s important to understand that you will either roll the closing costs into the new mortgage or exchange them for a slightly higher interest rate.
Because you’ll either fatten your loan principal or pay an increased rate, your monthly payments and total interest paid will likely be higher than if you had paid the closing costs with cash.
Still, a no-closing-cost refinance can help some homeowners make their finances more manageable. Read on to decide if a no-closing-cost refinance is right for you.
No-Closing-Cost Refinance: How Does It Work?
You know how they say that if something sounds too good to be true, it usually is? Well, that’s true in this case, too.
When you refinance a mortgage, you’re taking out a whole new loan, hopefully with a lower rate or shorter term.
The costs to do so are usually 2% to 5% of the total loan amount. For a refinance loan of $300,000, for example, that is $6,000 to $15,000, a big pill to swallow if the costs are to be paid upfront.
A no-closing-cost refinance means you get to take out a new mortgage without paying closing costs out of pocket or you accept a higher rate for the new loan.
Let’s break it down.
Closing Costs? What Closing Costs?
When a borrower signs mortgage documents, a variety of fees and expenses come along for the ride, which you probably remember from signing your mortgage the first time.
Right away or after a set number of months, depending on the kind of mortgage they have, homeowners can attempt to lower their mortgage rate and shorten their loan term or, if they’re sitting on enough home equity, apply for cash-out refinancing.
They may want to transition from an adjustable-rate mortgage to a fixed-rate mortgage — or a fixed-rate mortgage to an ARM.
Some may want to refinance their FHA or USDA loan into a conventional loan to get rid of mortgage insurance; others may be looking to refinance their jumbo loan.
If rates have fallen or if your creditworthiness has significantly improved since you took out your mortgage, those are among the signs it might be time for a mortgage refinance.
But there’s no free lunch when it comes to closing costs, even with a “no-closing-cost refinance.” The mortgage refinancing costs add up.
Here are expenses that might be rolled into the refinanced loan:
Lender fees. Borrowing money costs money! Your lender might assess an application fee, processing fee, credit report fee, and underwriting fee. Most but not all lenders charge an origination fee. Any points on the mortgage, aka discount points, may be rolled in.
Title insurance fees. A title search ensures that no one else can claim ownership of your home.
Other closing costs can’t always be rolled into the new loan. They include:
• Prepaid property taxes
• Homeowners insurance
• Any homeowners association dues
• Appraisal fee. The home appraiser’s fee is usually charged early in the closing process, so you probably won’t be able to add it to the new loan
If you compare no-cost refinance offers, ensure that each lender is willing to cover the same items.
And be aware that a lender that will cover lender fees, third-party charges, and prepaid items will probably charge a higher rate.
The Cost of a ‘No-Cost Refinance’
Given the heft of closing costs, a no-cost refinance might be sounding better and better. But whether you opt to accept a higher rate or roll in the closing costs, you’re still responsible for paying those costs over time.
And depending on their total expense, as well as the interest rate and mortgage term, closing costs can eclipse the savings you stand to gain by refinancing in the first place.
That’s why it’s important, given your anticipated new loan rate and term, to use a mortgage calculator and scour loan estimates you’ll receive after applying for a mortgage refinance to know the full amount you’ll pay over the life of the loan.
With any mortgage refinance that includes closing costs, it’s a good idea to look at the refinance break-even point: closing costs divided by the expected monthly savings. That will give you the number of months it will take to recoup the costs to refinance.
If a refinance adds $100 a month to your mortgage payment and your lender is covering $4,000 in closing costs, you’ll break even after 40 payments, or three years and four months.
Pros and Cons of a No-Closing-Cost Refinance
So-called no-closing-cost refinances have upsides and downsides to consider.
Benefits of a No-Closing-Cost Refinance
• This kind of refinance can help keep homeowners from owing a hefty bill all at once, making it possible to refinance if they don’t have a lot of cash on hand.
• By rolling costs into a home loan, you can keep cash on hand to use for other purposes that may be more important to you.
• If you opt for a higher rate, you won’t use up home equity on a no-closing-cost refinance.
Drawbacks of a No-Closing-Cost Refinance
• The closing costs may be compensated for in the form of a higher interest rate, which can be costly over time.
• If the closing costs are added to the principal loan balance, borrowers very likely will pay more interest over the life of the loan than they would have if they’d paid closing costs upfront.
• If your refinance lender won’t let you cross the 80% loan-to-value threshold when closing costs are added, you won’t have enough room to include the closing costs. If the lender will allow a higher than 80% LTV ratio, the new mortgage typically will require private mortgage insurance.
Is a No-Closing-Cost Refinance Right for You?
If you stand to save money by refinancing your home — and if you’ll be in your home long enough that you’ll break even on the refinance — it might be worth footing the elevated interest rate or higher loan principal of a no-closing-cost mortgage refinance.
For those who don’t have the cash on hand to pay for closing costs upfront, this approach is the only feasible way to achieve a refinance at all.
If, however, you’re able to pay the closing costs upfront, doing so can help keep the loan less expensive over its lifetime.
The Takeaway
With a no-closing-cost refinance, closing costs are either added to the new mortgage or exchanged for a higher interest rate. A no-cost refinance can make refinancing possible for those who can’t pay the closing costs upfront, but it’s important to look at costs over the life of the loan and your plans as a homeowner to ensure that it makes financial sense.
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This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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How often can you refinance your home?
Other than possible lender-imposed waiting periods after a mortgage loan closes, you can refi as many times as your heart desires. But you’ll want to crunch numbers and think about more than interest rates.
Homeowners choose to refinance for a number of reasons: to lower monthly payments, take advantage of lower interest rates, get better terms, pay the loan off more quickly, or eliminate private mortgage insurance.
Refinancing involves paying off the current mortgage with a second loan that has (hopefully) better terms. Borrowers don’t have to stay with the same lender—it’s possible to shop around for the best deals, and lenders will compete for that business.
Mortgage rates seem to be constantly in flux, moving mostly in parallel with the federal interest rate. Both were on a downward trend throughout 2020, and mortgage rates rang in the new year at 2.67% for a 30-year fixed loan and 2.17% for a 15-year fixed loan.
Rates that low could mean the chance for homeowners to save significant money. But should a killer interest rate automatically trigger a refinance? Here are some things to consider before taking the plunge.
Related: Home equity
loans vs personal loans for home improvement
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Because a homeowner who refinances is essentially taking out a new loan, the cost of acquiring the new loan must be compared with potential savings. It could take years to recoup the cost of refinancing.
As with the initial mortgage loan, a refinance requires a number of steps, including credit checks, underwriting, and possibly an appraisal.
Typically, however, many homeowners start with an online search for the rates they qualify for. (A low average mortgage rate doesn’t necessarily translate to an individual offer—creditworthiness, debt-to-income ratio, income, and other factors similar to what’s required for an initial mortgage will matter.)
The secret sauce that makes up a mortgage refinance rate might seem like a mystery right up there with how car sellers price their inventory, but there are some common factors that can affect your offer:
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As a general rule, higher credit scores translate to lower interest rates. A number of financial institutions will give account holders access to their credit scores for free, and a number of independent sites offer a free peek, too.
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Is the loan a 30-year fixed? A 15-year? Variable rate? The selected loan repayment terms are likely to affect the interest rate.
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A refinance doesn’t typically require cash upfront, as a first-time mortgage usually does, but any cash that can be put toward the value of a loan can help reduce payments.
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If a home loan is extra large (or extra small), interest rates could be higher. But generally speaking, the less the mortgage amount is compared with the value of the home, the lower the interest rates may be.
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Some refinance offers come with the option to take “points” in exchange for a lower interest rate. In simplest terms, points are discounts in the form of a fee that’s paid upfront in exchange for a lower interest rate.
Where the property is physically located matters not only in its value but in the interest rate you might receive.
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As with first-time home loans, consumers have a number of refinance mortgage options available to them. The two most common types involve either changing the terms of the original loan or taking out cash based on the home’s equity.
A rate-and-term refinance changes the interest rate, repayment term, or sometimes both at once. Homeowners might seek out this type of refinance loan when there’s a drop in interest rates, and it could save them money for both the short term and the life of the loan.
A cash-out refinance can also change the terms or interest rate, but it includes cash back to the homeowner based on the home’s equity.
Within those two basic types of refinance options, conventional mortgages from traditional lenders are the most common. But refinancing can also happen through a number of government programs.
Some, like USDA-backed loans, require the initial mortgage to be a part of the program as well, but others, such as the VA, have a VA-to-VA refinance loan called an interest rate reduction refinance loan and a non-VA loan to a VA-backed refinance, so it’s important to shop around to find the best option.
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If a home purchase comes with immediate equity—it was purchased as a foreclosure or short sale, for example—the temptation to cash out immediately with a refinance may be strong.
The same could be true if interest rates fall dramatically soon after the ink is dry on a mortgage. Especially for conventional loans that are backed by Fannie Mae or Freddie Mac, it may be possible to refinance right away. Others may require a waiting period.
According to credit-reporting company Experian, for example, there can be a six-month waiting period for a cash-out refinance. Or refinancing via government programs like the FHA streamline refinance or VA’s interest rate reduction refinance loan can require waiting periods of 210 days.
Lenders can require a waiting period (also called a “seasoning period”) until they refinance their own loans for a number of reasons, including insurance that the original loan is in good standing.
For a cash-out refinance, some lenders may also require that the home has at least 20% equity.
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As with other things in life, just because you can (refi) doesn’t necessarily mean you should. Before you jump on the refinance bandwagon, ask yourself these questions.
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The endgame of a mortgage refinance can help determine whether now is the right time. If a lower monthly payment is the goal, it can be wise to play around with a refinance calculator to see just how much a lower interest rate will help.
For years, it has been a general rule that a refinance should lower the interest rate by at least 2 percentage points to be worth it. Some lenders believe 1 percentage point is still beneficial (each percentage point amounts to roughly $100 a month in payment reduction), but anything less than that and the savings could be eaten up by closing costs.
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It’s important to remember that a lower monthly payment—even if it’s significantly less—doesn’t necessarily equal savings in the long run.
If a mortgage with 20 years remaining is refinanced to lower the monthly payment, for example, the most affordable option could be a 30-year mortgage. But is the lower monthly payment worth it if it will be around for 10 additional years?
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One of the biggest differences between a first-time mortgage and a refinance is the amount it costs to close the loan. Many times, closing costs for a refinance can be rolled into the loan, requiring no cash at the outset.
Closing costs typically come in at 2% to 5% of the loan amount, and although they can be rolled into the loan and paid off over time, that could mean the new monthly payment isn’t as low as planned.
One way to make sure the investment is worth the cost is to ask the lender for a break-even period.
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This article
originally appeared on SoFi.comand was
syndicated by MediaFeed.org.
SoFi Loan Products
SoFi loans are originated by SoFi Lending Corp (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal.
SoFi Home Loans
Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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