What is a no-closing-cost refinance?
Closing costs. Does any homebuyer like them? The idea of a no-closing-cost refinance might sound appealing, but even if you refinance a mortgage with no closing costs, you can still have expenses.
On your quest for the best available package, it's important to know that in a no-closing-cost refi, those costs don't simply disappear: they might get rolled into your loan amount.
What is a no-closing cost refinance?
If you’re looking to save on a mortgage refinance, a no-closing cost plan will only reduce your upfront expenses. Rather than settling these fees at the loan’s conclusion, this option delays the payment, which is settled later throughout the life of the loan.
As a result, your monthly mortgage payments would increase, either in the form of a larger principal balance or higher interest rate. Since most borrowers turn to refinancing as a means of saving on their monthly expenses, a no-closing cost refinance might only make a marginal difference and might not necessarily be worth the investment.
If you qualify for a no-closing cost refinance, that 3%-6% in closing costs of your principal balance will be redistributed in one of two ways. Depending on your lender, they’ll either charge a higher interest rate or include those fees in the amount they lend.
Whichever means they offer, you’ll end up paying more each month than if you pay the closing costs upfront.
No-cost refinance with higher interest rate
If your lender won’t fold those costs into your overall balance, you’ll be set with a higher interest rate. Since closing costs usually amount to 3%-6% of the loan amount, translating that expense into interest can raise your rate by as much as 0.5%.
Half a percentage point might not seem like much, but over the life of a 30-year mortgage, for example, those payments really stack up. Be sure to do the math and make sure you can afford a higher mortgage interest rate before going through the refinancing process.
No-cost refinance rolling closing costs into the loan
Another option your lender might present is to fold those costs into the overall loan amount, meaning your total balance increases. Refinancing a $200,000 home, let’s say, could require closing costs of roughly $10,000.
Financing that expense into the loan amount means you’ll have to pay off $210,000 in the same amount of time. Once again, this option can significantly increase your monthly mortgage payment.
Mortgage Acts and Practices-Advertising Rule
However, despite the drawbacks of a no-closing cost refinance, previous buyers have signed on to these agreements only to learn those costs were redistributed elsewhere in their lenders amortization plan. In order to prevent this type of oversight, and to restrict lenders from making false or misleading mortgage claims, the Federal Trade Commission enacted the Mortgage Acts and Practices-Advertising Rule, also known as “MAP.”
Under this regulation, lenders are not permitted to advertise “no-closing cost refinances” as an elimination of those expenses altogether. Instead, your lender will need to provide an upfront loan estimate, which outlines the terms of the new mortgage and itemizes each payment and when it needs to be settled.
What are the closing costs when refinancing?
Throughout the refinance process, you and your lender will work with a number of third-party services required to finalize terms. The charges and fees associated with these service providers are usually covered by the buyer as part of the home’s closing costs. This isn’t a comprehensive list, but are the main costs you’ll be set with at closing. If you chose a no-closing cost refinance, these expenses will be redistributed in the ways discussed above:
- Loan origination
- Appraisals
- Title insurance
- Credit report
For a more comprehensive list see: What Are the Costs of a Mortgage Refinance
Loan origination
A portion of the closing costs on a mortgage refinance will usually go toward loan origination fees. Typically 0.5%-1% of the principal, these expenses are paid to your lender for general processing and underwriting of your application.
This fee covers the lender’s initial services when working with you to establish the financing contract. While interest payments represent the cost of borrowing money, loan origination fees are the cost of getting that loan off the ground.
In a typical refinancing agreement, the exact parameters of this expense will be defined on your closing disclosure.
Appraisals
Before agreeing to a refinancing plan, lenders will always require an appraisal of the home. This step provides an impartial market value estimate of the home, while protecting the lender from an inflated market value. In the event of foreclosure, appraisal is necessary to ensure that the property value supports the loan terms and is sufficient collateral to secure repayment.
In a typical refinance arrangement, the cost of the appraisal would be carried by you, the homeowner. These fees are typically included in the closing costs, while a no-closing cost refinance arrangement would settle the appraisal fee down the line.
Title insurance
In order to sign off on a refinance arrangement, your lender will require their own title insurance policy. This coverage guards your lender against any issues that can arise from additional legal claims on the property.
Even though title insurance protects the lender against claims that impact the loan, the coverage is still paid for by you as the borrower. These costs are usually settled at closing, but can be otherwise settled through a no-closing cost refinance.
Title insurance for buyer
Your own title insurance policy, on the other hand, protects your claim to the property in the event that another individual comes forward with their own claim.You received an Owners Title Insurance Policy from the seller when you purchased the property. It is not common for the Lender to require anything at the time of refinance other than a new Lender's Title Insurance Policy.
If you do end up having to secure a policy, those costs are typically included in the closing costs. If you move forward with a no-closing cost refinance, this will be yet another expense that will need to be satisfied later on, either in the form of a higher interest rate or larger loan amount.
Credit report
Credit reports provide a record of an applicant’s financial history and ability to repay debts. This summation of your financial background is required by lenders, who will conduct a thorough review of your financial background to determine your loan’s terms and your refinance eligibility.
Any history of unpaid debts, settled loans or previous credit applications appear on this report, giving lenders an idea of the risk in providing you with financing, helping to establish an appropriate interest rate and repayment plan.
Pulling these reports typically includes a fee, which would be included in your refinancing closing costs.
In conclusion
While a no-closing cost refinance might sound like a great way to save money, it’s not a way of foregoing those expenses entirely. Always keep in mind that these costs will need to be settled down the line, either folded into your financing plan or absorbed into your interest rate, resulting in higher monthly payments.
This type of refinancing will always result in a higher mortgage bill than if closing costs are paid in the traditional manner. If it’s the perfect time to refinance, but you lack the money to cover the costs of a new loan, a no-closing cost refinance could work for you.
A great way to find out which refinancing plan fits your goals is to meet with multiple lenders and compare who has the best option. Mortgage refinance calculators can also be a helpful tool when deciding whether the timing is right. Above all, however, the expertise of a loan officer can provide invaluable guidance for your refinance journey.