How Does a No-Cost Refinance Work?

If you’re a homeowner looking to refinance your mortgage, you know it can be confusing sorting through all of your financial options. Loans can be complicated, especially when you’re under pressure to refinance. In fact, it can be downright overwhelming.

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Take, for example, a no-closing-cost refinance. While it may sound too good to be true, there are times when it may be worth considering. Here’s a guide to help you understand:

What is a no-cost refinance?

In short, it’s a mortgage loan that offers homeowners the option to refinance their mortgage without having to pay initial fees to lenders.

Closing costs usually pay for lender fees as well as loan origination fees, third-party expenditures, appraisal fees, and underwriting and processing costs. Refinance lenders also take on costs that originate from third parties, including escrow and title costs.

With no closing costs, homeowners can refinance their homes without spending anything upfront or throughout the application process. It’s certainly tempting and may be the right choice for certain types of borrowers. However, those closing costs saved are costs added to the loan amount that you’ll eventually have to pay back.

Here are a few features of a no-closing-cost refinance:

  • Zero extra fees from loan applicants
  • Broker or lender pays lender and settlement fees
  • Higher refinance rates may be a result

What are the pros and cons of no closing costs?

Having no upfront closing costs comes with a range of both advantages and disadvantages. The idea of skipping the closing costs and fees upfront may be appealing, or even right for you. However, it’s still important to take into account the various ways it may affect your financial situation next month, next year, and next decade. Here are some pros and cons:

  • No cost up front
  • Save cash in the short term
  • May result in higher monthly payment to make up for reduced costs upfront
  • Pay more in interest over the course of the loan

Every situation is unique, as is every homeowner. No closing costs upfront may be best for you if you’re currently in a tight financial spot. It may be worth it to spend more in the long term if you don’t have the cash to pay for closing fees and other third-party costs at the time of borrowing.

This may be an appealing option if you’re focused on devoting more money to savings or retirement accounts, which can further accrue over the life of the refinancing loan.

On the other hand, if you have immediate access to funds to pay the closing costs at the time of the application, you’ll have a lower monthly mortgage payment over the years. That comes as a result of savings in interest rate over the years, as closing costs will be rolled into a higher refinance rate.

Ultimately, if you take on a no-closing-cost loan, you’ll most likely end up with a slightly higher interest rate over time.

Have you read the fine print?

Before you get excited about not paying anything upfront, sit down with your lender to discuss all the details. Be sure to keep an eye out for the following details:

  • Some loans are not actually “no cost”
  • Some loans solely cover lender fees, while others may cover all expenses including third-party costs
  • Home loans differ from lender to lender, so it’s important to shop around
  • Lenders may pay different interest rates and costs on your behalf. Find out all the details before you commit
  • Consider all the costs: title and appraisal, lender fees, escrow, home inspections, mortgage points and other third-party fees

Is it right for you?

Consider how it will affect your financial status, both now and in the years to come. For example, it may require zero, or close to zero, fees at the time of signing but will raise your mortgage rate over time.

Right off the bat, added expenses over the years may not sound great. However, if you intend to move within the next few years, taking on low-to-no costs upfront may offset the savings if you kept mortgage rates low over the life of the loan. If you’re not going to be in your current home for long, it may make sense to save now and spend a bit more over the next year or two.

In contrast, if you’re 10 years into a 30-year mortgage, it may be tempting to skip paying fees at the time of signing. However, it may not be worth it to sign up for a no-closing-cost refinance. Fees and interest continue to accrue and will continue to do so each month until the loan has been paid in full.

Sit down and do the math to see what costs and benefits will add up to over the years. Be sure to shop around to make sure you’re getting the best deal, regardless of whether you decide to select a loan with no upfront closing costs.

Remember, while the loan may not cost anything at first, nothing comes for free. Eventually, you’ll have to pay for the fees you skipped at the time of signing, and that will show in your monthly mortgage bill.

What does a “no closing cost mortgage” really look like?

Now that you understand the positives and negatives of selecting a no-closing-cost refinance, here’s an example of how these loans may play out in a lending setting:

For example, you may be charged $4,500 in closing costs, the average cost for homeowners today. If you choose to pay this out of pocket, the $4,500 cost will remain static as a one-time charge.

On the other hand, if you skip those fees, that sum will be rolled into your mortgage bills each month over the duration of that loan. Over 30 years at 4.125 percent interest, the borrower will eventually pay a total of $7,851.

Meanwhile, over the course of five years, the borrower will wind up paying $6,000 after initially skipping the $4,500 closing fee.

Whether this is worth it or not is entirely up to you. If you’re planning to sell your home within the next couple of years, the immediate savings may be worth it for you to pay a bit more over two years.

You can take that saved money to invest in repairs, remodels, realtor fees, and other associated costs that accompany selling a home. Moving a home quickly on and off the market can save you other costs that make this type of loan right for you.

What are the warning signs of a bad deal?

No-closing-cost loans are each different from one lender to another. By seeking out different opinions and home equity options, you can ensure that you’re getting a good deal. Here are a few warning signs to look out for:

  • The loan is called “no cost” but it turns out you’ll have to pay for appraisals, title fees, escrow, property taxes, insurance, and prepaid interest.
  • The loan is called a “no lenders fee loan,” which means the bank will only cover just that—lenders fees, and nothing else.
  • Carrying out a refinance through a mortgage broker, who then adds on a lender credit, further increases your interest rate.
  • A bank uses “bundles” that tack on closing costs on top of the cost of the loan. These bundles further increase the size of the loan, as well as the interest rate, leading to a higher monthly payment over time.

Be mindful of these warning signs. It’s alright to take your time when seeking any type of home loan. That’s especially true if the deal feels murky and you’re having trouble finding out all the details of the loan before you’re rushed to sign.

Should you negotiate?

Yes! Everything is up for negotiation, and that includes applying for a no-closing-cost refinance. Do your research to seek out the lowest costs at the most responsible rate you can.

Present your lender with research that shows you’re knowledgeable and that you’ve done your homework. Then don’t be afraid to negotiate.

If you plan to stay in your current home for the next 30 years or are hoping to relocate in the next couple of years, it’s your home and your financial future. Take charge and only enter a lending situation when you’re fully comfortable with the terms and outcomes.

Anne Bouleanu
Meet the author

Anne Bouleanu is a freelance journalist based in Chicago. She has worked with outlets including the BBC, Bloomberg, and Al Jazeera, among others.