Refinancing your mortgage is a powerful way to restructure your finances. It lets you switch loan types, change your loan term, and possibly get a lower interest rate — all of which can save you money.
But to get those advantages, you need to pay closing costs — typically several thousand dollars. Many lenders may tempt homeowners considering a refinance by offering a no-closing-cost refinance, which is a bit of a misnomer. You still pay closing costs — you just don’t pay them upfront. While this saves you money at closing, it often will cost more in the long run.
Key Takeaways:
- A no-closing-cost refinance means you’ll pay for the fees associated with taking out a loan in other ways, such as with a higher loan amount or a higher interest rate.
- It’s important to consider the pros and cons of a no-closing-cost refinance so you can determine if skipping upfront fees is worth a more expensive mortgage.
- There also are alternatives to a no-closing-cost refinance, such as negotiating with your lender, and comparing rates to make sure you’re getting the best possible deal.
What Is a No-Closing-Cost Refinance?
Despite its name, a no-closing-cost refinance doesn’t mean you don’t pay those fees — you’re just not paying them at closing. A no-closing-cost refinance usually compensates the lender for paying your closing costs upfront by increasing other loan costs — often by raising the interest rate or adding the closing costs to the loan amount.
How much are closing costs on a refinance?
When you refinance your mortgage, you pay many of the same closing costs you paid to get your purchase loan. These costs usually include an application fee, an origination fee, the refinance home appraisal fee, and title insurance.
Refinance fees cost $5,000 on average, according to Freddie Mac. They can run even higher, depending on the type of mortgage you have, your mortgage lender, and where you live.
How No-Closing-Cost Refinances Work
Lenders usually recoup the cost of paying the borrower’s closing costs upfront by raising your mortgage interest rate or adding the closing costs to the mortgage principal.
You pay a higher interest rate
Increasing your interest rate even a little bit to cover closing costs can add up to you paying a lot more money over the life of your loan.
Say you want to refinance your current mortgage into a 30-year, fixed-rate loan for $300,000 at 7% interest that requires you to pay $5,000 in closing costs. If you lack the cash to pay closing costs upfront, your lender may offer you a no-closing-cost refinance with the same terms but an interest rate of 7.25%.
That would raise your monthly payment from $1,996 to $2,046, and your overall interest costs would increase from $418,527 to $436,750 — costing you $18,223 to avoid paying $5,000 in closing costs upfront.
You borrow more money
The other common scenario is for the lender to add the closing costs to your loan amount. That means you’ll borrow more than the purchase price and repay your closing costs and principal — with interest — as part of your monthly mortgage payment.
“Costs are instead absorbed into the loan and repaid as part of the amortization schedule,” says Kevin Bazazzadeh, owner of the real estate investment company Brilliant Day Homes in Houston.
Revisiting our example: Adding $5,000 in closing costs to your loan’s balance means you’re now borrowing $305,000 at 7% interest. Your monthly payment would go up to $2,029, and the total interest paid would be $425,502 over the life of the loan. In addition to borrowing and repaying the extra $5,000, you would pay $6,975 more in interest than if you paid the closing costs upfront.
Pros and Cons of a No-Closing-Cost Refinance
A no-closing-cost refinance can be worthwhile in certain situations, especially if you need to refinance but have no money saved up for closing costs. Even in such cases, though, there are drawbacks to consider.
Pros of a no-closing-cost refinance
Potential benefits to choosing a no-closing-cost refinance include:
- You don’t need cash to refinance. The obvious perk of no-closing-cost refinancing is you don’t need to pay thousands in closing costs upfront. This can let you take advantage of refinancing to a lower interest rate even without having money saved for closing costs.
- You still can save money overall. If interest rates are low enough that you can finance your closing costs and still reduce your monthly payment and overall interest costs, you can save thousands with a refinance.
- Interest rates may be lower than for other loan types. Lower rates on a no-closing-cost refinance can save you more than taking out another type of loan, such as a home equity loan, to pay your closing costs.
Cons of a no-closing-cost refinance
On the other hand, a no-closing-cost refinance can be a more expensive option.
- You likely will pay more overall for closing costs. Skipping the upfront payment means you’ll have a higher monthly mortgage payment and will pay more overall for an expense that has little long-term value.
- You might need private mortgage insurance. If rolling refinance closing costs into the principal reduces your home equity to less than 20%, then you may have to pay for PMI.
- You risk increasing your debt-to-income ratio. The higher monthly payment on a no-closing-cost refinance will increase your DTI ratio. If it goes above the maximum allowed by your lender or loan type, your refinance application may be denied.
Alternatives to No-Closing-Cost Refinancing
If you’re thinking twice about a no-closing-cost refinance, there are other ways you can try to make refinancing more affordable.
Save for closing costs
If interest rates are expected to remain steady — or could drop soon — you could wait to refinance while saving up for closing costs. If rates fall, you could save money both from paying your closing costs upfront, and a lower interest rate.
Shop around and compare loans
Whenever you’re applying for a loan, it’s a good idea to shop around and compare mortgage offers and refinance lenders. You also can shop around for some of the services required to refinance, such as the title company or appraiser. Your loan estimate will show which services you can shop for and which you cannot.
Negotiate with your lender
You also can ask your lender to waive some closing costs. While you won’t get all of them waived, the lender may be willing to skip some fees or reduce your closing costs to keep or earn your business.
FAQ: What Is a No-Closing-Cost Refinance?
Here are answers to common questions about no-closing-cost refinances.
To determine whether any refinance is worth doing, you’ll have to run the numbers and compare the overall cost of your current loan with the new one. If refinancing saves you money overall or makes your monthly payment more affordable, it may be worthwhile for you.
No. The reality is that closing costs need to be paid one way or another. If you don’t pay them upfront, your lender will pay them and charge you more in some other way to compensate.
Yes. Almost everything is negotiable, but it’s unrealistic to expect any lender to waive all your closing costs. Some loan types, like those backed by the Federal Housing Administration, have mortgage insurance premiums that cannot be waived.
The Bottom Line on No-Closing-Cost Refinances
It’s important to understand that refinancing a mortgage is not free. But if you can’t afford to pay thousands upfront on closing costs, and your loan terms save you money, it can be a good move. Just be sure you understand the rules of the game.
T.J. Porter contributed to the reporting of this article.
