A Guide To The No-Closing-Cost Refinance
Kevin Graham6-minute read
February 21, 2021
Many homeowners underestimate exactly how much they need to pay in closing costs during a mortgage refinance. Are closing costs stopping you from getting a refinance? If so, a no-closing-cost refinance might be right for you.
We’ll take a look at the true cost of no-closing-cost refinances, learn a little more about closing costs during a refinance and discuss why you’d want to choose a no-closing-cost refinance for your home.
What Is A No-Closing-Cost Refinance?
As the name suggests, a no-closing-cost refinance is a refinance where you don’t have to pay closing costs when you get a new loan. But just because there are no upfront costs doesn’t mean that your lender foots the bill for free. No-closing-cost refinances don't get rid of a borrower's expenses; they only move them into your principal or exchange them for a higher interest rate.
The simplest no-closing-cost refinance takes the amount that you would have paid during closing and tacks it onto your new mortgage. In other words, your lender adds the balance of your closing costs to your principal, or the unpaid balance of your loan. This increases your monthly payments but doesn’t affect your interest rate.
Your lender may also allow you to take a higher interest rate in exchange for waiving your closing costs. Your interest rate is the amount you pay to your lender per month for borrowing. Refinance interest rates depend on many different factors. A higher interest rate doesn’t change your principal amount, but you'll still pay more each month.
Average Closing Costs When Refinancing
Just like when you first bought your home, there are a number of fees and expenses your mortgage lender will schedule for you. As the homeowner, you’re responsible for covering the closing costs to finalize your new loan. Some of the closing costs you may see when you refinance include:
Loan Origination Fee
You’ll pay an origination fee to your lender to prepare your loan. The average origination fee is 0.5% – 1% of the loan amount. This is in the same origination charges section of your loan estimate as discount points. We’ll get into those later.
During an appraisal, a professional comes to your property to assess its value. When you refinance, you’ll need to get another appraisal to ensure your property value hasn’t drastically changed since you bought the home. Most appraisers charge $300 – $500 for their services.
You receive a document called a deed when you buy a home. A title shows that the seller transferred legal ownership of the home to you. Title insurance protects you from errors in the ownership records of your home or property. You’ll need to buy a new title insurance policy when you refinance your mortgage loan because the refinance is a new loan. Most title insurance companies offer significant discounts for returning customers who already bought a policy when they first bought the home.
VA Funding Fee
Are you refinancing a VA loan? You’ll need to pay a percentage of your new loan back to the Department of Veterans Affairs. The amount you pay for the VA funding fee depends on the type of refinance being done.
If this is your first time using a VA loan and you’re refinancing from a different loan type (conventional, FHA, etc.), the funding fee is 2.3%. If you’re coming from a different type of mortgage, but you’ve used a VA loan in the past, the funding fee is 3.6% of the loan amount.
If you’re doing a refinance where you’re going from one VA loan to another – a VA Interest Rate Reduction Refinance Loan (IRRRL), also known as a VA Streamline, the funding fee is just a 0.5% of the loan amount.
There are those that are exempt from paying the VA funding fee including those receiving VA disability. Additionally, surviving spouses receiving Dependency Indemnity Compensation (DIC) are exempt. Finally, the last exemption applies to Purple Heart recipients who are on active duty.
FHA loans have an upfront mortgage insurance premium of 1.75% of the loan amount if you’re refinancing from another type of loan to an FHA loan. If you’re doing an FHA Streamline, (from one FHA loan to another, the funding fee is 0.01% of the loan amount. In either case, these can be built into the loan balance.
Conventional loans have the option of what’s called single-pay mortgage insurance. Rather than pay for mortgage insurance on a monthly basis until you get to have at least 20% equity or opt for the higher rate associated with lender-paid mortgage insurance (LPMI), you can choose to pay off some or all of the mortgage insurance policy at closing in order to get a lower rate for the life of the loan.
Credit Report Fee
Lenders need to make sure that your credit score hasn’t gone down since you initially bought your home. Some lenders pass the fee of checking your credit score back onto you during closing. Credit report fees typically range from $25 – $50 depending on the lender and your state of residence.
Discount points are optional; they’re the fee you pay your lender in exchange for a lower interest rate. Each point costs 1% of your total loan amount, and you can buy multiple points. For example, one point on a $100,000 refinance would cost $1,000. You may also see these referred to as prepaid interest or mortgage points.
Whether it makes sense to purchase discount points depends on the amount you save on your monthly payment by buying them and how long you plan to stay in the house. Let’s run through a quick example.
Let’s say you’re considering whether to purchase 2 points on a $300,000 loan to save $75 per month. The points would cost you $6,000 and the key is to calculate the breakeven point. In this case that’s 80 months ($6,000/$75 equals 80).
If you plan on staying in the home for at least 6 years and 8 months, then purchasing the points make sense. If you don’t plan to stay that long, either don’t buy the points or buy a smaller amount.
Other Costs Associated With The No-Closing-Cost Refinance
You can choose between two different options with a no-closing-cost refinance: either an increased interest percentage or a higher loan balance. Not every lender offers both types of no-closing-cost refinances, so make sure your lender can offer you the option you want.
Increased Mortgage Rates
You’ll need to accept a higher interest rate if your lender offers you a no-closing-cost refinance without adding funds onto your principal. A higher interest rate doesn’t change your principal loan amount. Even a small change in your interest rate can mean you’ll pay much more over time. Let’s look at an example.
Say you refinance your $150,000 home at 3.5% interest over a 15-year term. Your closing costs would usually be between 3% – 6% of your total loan amount. In this case, let’s say your closing costs are $6,000. You’d end up paying a grand total of $43,018.31 in interest over the course of your refinance with this interest rate. The total will be a little over $49,000 when you add in your closing costs.
Now, your lender offers to waive your closing costs if you agree to take the same loan but with an interest rate of 4.1%. In this instance, the total amount you’d end up paying in interest by the time you pay off your loan is $51,071.47. This means that you’d pay over $2,000 more for your loan.
As the interest rate increases, the amount that you end up paying increases. Crunch the numbers before you agree to take a loan with a higher interest rate.
Higher Loan Balance
When you choose to roll in your closing costs, your total loan balance increases. For example, let’s say that you’re refinancing a $150,000 loan with $5,000 in closing costs. Your monthly payment will be higher than it would be with a $150,000 loan.
Let’s compare the difference between a $150,000 refinance and a $155,000 refinance at a 3.5% interest rate. Let’s also assume that the loan’s term is 15 years. For the $150,000 refinance, your monthly payment would be $1,072.32 including principal and interest. With a $155,000 refinance, your monthly payment would be $1,108.07. That’s a difference of about $36 a month. Because there’s a higher balance, you’ll also pay $1,433.89 more in interest than you would on the $150,000 loan, although the increase isn’t as great as what we saw by taking the higher interest rate on the same loan amount.
Before you roll in your closing costs, make sure you can cover the higher monthly payment.
The Benefits Of A No-Closing-Cost Refinance
A no-closing-cost refinance can allow you to keep your refinance plans on track. If you’re planning to refinance and you need money to cover a sudden bill, a no-closing-cost refinance can actually save you money. Interest rates on mortgages are usually lower than home equity loans, which means that even if you take a slightly higher rate, you may end up paying less compared to another type of loan.No-closing-cost refinances work best if you plan to stay in your home for less than 5 years. This allows you to avoid paying closing costs as a lump sum, and you’ll sell the home before you pay thousands more in interest over the life of the loan.
When A No-Closing-Cost Refinance Doesn’t Work
The less time you plan to live in your home, the more it makes sense to choose a no-closing-cost refinance. If your current home is your “forever” home, you’ll usually end up paying more over time with a no-closing-cost refinance than you would by paying your closing costs upfront.
Still not sure if a no-closing-cost refinance is right for you? Ask your lender for the interest rates and loan differences in addition to using a mortgage amortization calculator to crunch the numbers. Compare what you’d pay in interest between a no-closing-cost refinance and a standard refinance and then see which option makes the most sense for you.
Is A No-Closing-Cost Refinance Right For You?
A no-closing-cost refinance can help you finish your refinance without paying thousands in closing costs upfront. However, “no closing costs” doesn’t mean your lender foots the bill. Instead, you’ll pay a higher interest rate or get a higher loan balance.
Choosing a no-closing-cost refinance may make sense if you don’t plan on staying in your home for very long. But if you plan on living in your home for a long time, you may end up paying thousands more in interest by taking a no-closing-cost loan.
The right decision for you depends on your individual situation. Knowing what you’re comfortable paying each month and understanding all of your options can help you make the right decision when you're ready to refinance.
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