Refinancing might make sense right now since rates continue to stay low. The downside, however, is how expensive it can be to refinance. What if you could refinance with no closing costs? Wouldn’t that be a dream come true?
The good news is that you can refinance without paying closing costs. The bad news, though, is that it’s not always to your benefit to do so.
We discuss your options and their consequences below to help you make a decision.
Securing the Refinance With No Closing Costs
The secret to avoiding paying $4,000 or more in closing costs is to ask for a ‘no closing cost refinance.’ Sounds simple, right? It might be, but it could also cost you in the end. Some lenders are willing to give you a refinance with no closing costs. In exchange, they charge a higher rate. Typically, they charge a 0.5% higher rate than if you paid the costs at the closing.
Let’s look at how this affects you:
If you take out a $150,000 loan for 30 years at a rate of 4.0%, your P&I payment = $716
If you take out a $150,000 loan for 30 years at a rate of 4.5%, your P&I payment = $760
That doesn’t sound like a lot, but over the course of 30 years, it’s a difference of $15,840.
There’s one more way lenders allow you to pay no closing costs upfront. You can roll them into your loan. You need enough equity in the home to do this, though. You’ll need room for an average of $4,000 in fees. Depending on the loan program you choose, this could affect your eligibility. Many conventional lenders require a max LTV of 80% on a cash-out refinance, for example.
If you wrap the closing costs into your loan, what you do is increase your principal balance. Let’s say you originally had an outstanding balance of $150,000. If you wrap $5,000 worth of closing costs into your loan, your principal balance just became $155,000.
The Downside to Paying No Closing Costs
While it sounds amazing to not have to fork over $4,000 – $5,000 at the closing, there are downsides.
We already discussed one above. You pay more over the course of the loan. You can do a lot with $15,840 over the course of 30 years! Saving that $4,000 at the closing suddenly does not sound too enticing, right?
The same is true if you wrap the closing costs into your loan. A loan amount of $155,000 at 4% gives you a P&I payment of $740. That’s $8,640 more for this loan over the course of 30 years versus the $150,000 loan at 4% for 30 years. Again, the savings of $4,000 at the closing doesn’t sound so good.
When Does it Make Sense to not Pay Closing Costs?
If there are so many downsides to not paying closing costs, does it ever make sense to go this route? It does. It just depends on your situation.
The person that plans to stay in their home for the long-term and will not refinance in the next 5 years does not benefit from paying no closing costs.
However, the borrower that will move in the next 5 years or that refinances often may benefit. Taking a slightly higher interest rate for 5 years will generally not equal nearly as much as you would have paid for closing costs. You just need to make sure the situation you are in is temporary. If there’s a chance you’ll stay for the long-term, consider paying the closing costs.
The same is true for the borrower that refinances often. If you know you will pay off the loan soon, you may benefit from not paying closing costs. You might pay a slightly higher rate, but if you refinance out of it soon, it won’t matter.
Find Your Break-Even Point
In any refinance, with or without closing costs, it makes sense to find your break-even point. At which point does it make sense to refinance? When will you start seeing the benefit? If you are refinancing to save money, when will you start seeing those savings if you pay closing costs?
If you don’t pay closing costs, how much will the loan cost you over its entirety? At what point will it start costing you to live in the home rather than paying off the mortgage?
These are the things you must consider when you are faced with the chance to pay no closing costs. While it sounds like a great deal, it is not always the case.
Talk to your lender and determine your options. You can even shop around with different lenders. Each lender will likely give you a different quote based on what they can afford. This can help you determine which loan is right for you, saving you the most money.