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Every borrower wants to save money when they're refinancing their mortgage, often by securing a lower interest rate that drives down their monthly mortgage payments and saves them thousands over the life of the loan.
But does a no-closing-cost refinance fit into the money-saving category? Sure, this type of refinance might sound appealing—after all, the average closing costs for a single-family home in the U.S. were $5,749 (including taxes) in 2019, according to real estate data firm ClosingCorp. Yet even though a no-closing-cost loan lets you refinance without any upfront fees, it could very well trigger a rise in your interest rate or loan balance. That, in turn, could cause your monthly mortgage payments to climb and increase the total cost of the loan.
That said, a no-closing-cost refinance might be a good option if you don't have enough money saved up to cover the closing costs or you'd rather spend that money on a home remodeling project.
Read on to understand the ins and outs of no-closing-cost mortgage refinance loans.
How Does a No-Closing-Cost Refinance Work?
Not every lender defines a no-closing-cost refinance the same way—but make no mistake, any way it's defined doesn't mean there are no closing costs on the loan; it just means you won't pay them upfront in cash. Generally, though, there are two types of no-closing-cost refinance:
- The lender pays your closing costs (such as loan origination fees and appraisal fees), but charges you a higher interest rate. The higher rate remains until you pay off the loan or you refinance again.
- The lender rolls your closing costs into the loan. When that happens, the costs are added to the principal that you owe. You'll be able to skip paying the closing costs upfront, but you'll wind up paying these costs—with interest—for the life of the loan.
Either way, your monthly mortgage payment is bound to go up. When the lender covers the closing costs, the higher interest rate will bump your monthly mortgage payment but won't change the principal. If the lender combines your closing costs with the principal, your monthly mortgage payment will jump but the interest rate will stay the same.
Examples of closing costs include:
- Application fee
- Appraisal fee
- Inspection fee
- Loan origination fee
- Prepayment penalty
- Survey fee
- Title search and title insurance
Because a no-closing-cost refinance can boost your interest rate and your monthly mortgage payments, this kind of refinance typically isn't recommended.
Pros and Cons of a No-Closing-Cost Refinance
As with any type of loan, a no-closing-cost refinance has advantages and disadvantages. Here are some of them.
Pros of a No-Closing-Cost Refinance
- The No. 1 pro of this type of refinance is that you don't need to come up with thousands of dollars upfront to pay the closing costs, which can range from 2% to 5% of the loan principal.
- A no-closing-cost refinance might be a good choice if you're thinking about selling your home within five years or you're considering another refinance in the near future. Avoiding the upfront closing costs now and making slightly higher mortgage payments for a relatively short time could make financial sense.
- If you're setting aside money for a home remodeling project, it might be better to go with a no-closing-cost refinance so you can use the extra cash for your project.
- When you take closing costs out of the picture, it can simplify shopping for a mortgage refinance loan by helping you more clearly compare interest rates from various lenders.
Cons of a No-Closing-Cost Refinance
- You'll likely see your monthly mortgage payments go up. That's because the interest rate or principal will probably increase.
- You might pay more money over the entire life of your loan than you otherwise would.
- A lender might impose a prepayment fee to deter you from refinancing within the first few years after you've taken out the refinance loan.
When Might a No-Closing-Cost Refinance Make Sense?
While a no-closing cost refinance does come with some serious drawbacks, this kind of loan might make sense if you:
- Don't have enough money in the bank to pay the closing costs upfront.
- Don't want to touch the money in your emergency fund to pay the closing costs upfront.
- Do plan to sell your home within the next five years.
- Do plan to pay off the refinance loan within the next five years.
- Do want to renovate or repair your home. Securing a no-cost-refinance might be a smarter move, enabling you to hang on to cash for the project and avoid taking out a home equity loan, which could be a costlier option.
Alternative Ways to Reduce Mortgage Refinance Fees
Getting a no-closing-cost loan isn't the only way to cut down on mortgage refinance fees, which vary from state to state and from lender to lender. Here are three other possibilities:
- Improve your credit score. A higher credit score might enable you to obtain more favorable lending terms than someone with a lower credit score. This could include the ability to qualify for reduced fees, such as a lower loan origination fee. The origination fee usually ranges from 0.5% to 1.5% of the loan principal. You can get a free credit score through Experian to see where it stands.
- Negotiate with the lender to reduce or eliminate refinance fees. Don't be afraid to ask for breaks on the upfront fees (closing costs), or on ongoing fees like those for making a late payment or paying off your loan early. Where should you begin? Start with your current lender. They might be eager to slash or waive fees in order to keep you as a customer.
- Shop around for the best refinance deals from different lenders. Aside from fees, consider each lender's interest rates and reputation—and remember to tell your current mortgage lender that you're shopping around.
The Bottom Line
"No closing costs" may sound enticing, but even a no-closing-cost mortgage refinance comes at a price. Although you can avoid upfront closing costs with this type of loan, you'll normally pay those costs in some other form.
A no-closing-cost refinance does provide some benefits. For instance, it lets you refinance your mortgage if you don't have enough money in the bank to pay the closing costs upfront. However, before you sign the paperwork for a no-closing-cost refinance, closely study the details. This includes asking what a mortgage finance would look in different scenarios based on the proposed upfront costs, interest rate, monthly payments and other factors. Most important, consider whether the benefits of a no-closing-cost refinance outweigh the drawbacks.