Refinancing a mortgage can be attractive for a number of reasons. Often times, homeowners save money by refinancing when the interest rate is lower than what they are currently paying. A cash out refinance can allow them to use their home equity to pay for home repairs or consolidate debt. Or they want to move from a variable rate mortgage to a more predictable fixed rate mortgage. Whatever the motivation, it’s important to consider closing costs, including whether or not a refinance with no closing costs might be the right choice.

What is no-closing-cost refinancing?

Refinancing a mortgage is not much different from taking out a mortgage. For example, the borrower can expect to pay closing costs for the loan. These can include things like:

• Official admission fees
• Appraisal fees
• Credit Report Fees
• Origination fees
• Survey fees
• Tax service fees
• Legal fees
• Subscription fees

According to Freddie Mac, there are typically closing costs of about $ 5,000 in refinancing. As with other home loans, these closing costs are usually due when you sign the paperwork to close the new loan.

If you refinance without closing costs, you do not have to pay these fees out of pocket. However, that does not mean that there are no acquisition costs at all. Instead of having them pay when you take out the loan, lenders can collect these costs in two ways:

• Charge a higher interest rate on the new loan
• Including the closing costs in the principal amount of the new loan

Both options will affect the total cost that you will pay for the new mortgage.

This is how a no-closing-cost refinancing works

If your lender offers refinancing with no closing costs, you may have the choice of paying a higher interest rate or adding the closing costs to the new loan. Here’s how each one works and how they affect your costs.

Option 1: Pay a higher interest rate

Opting for a no closing fee loan with a higher interest rate means a higher monthly payment and also affects the total amount you will pay over the life of the loan.

For example, let’s say you have 25 years remaining on a 30 year 4.2% mortgage and you currently owe $ 250,000. Since you want to reduce your monthly payments, opt for a refinancing in a new 30-year loan at 3.2%. The closing cost is estimated at $ 5,000 and you choose to pay it out of pocket. The new loan reduces your current monthly payment by $ 141 – from $ 1,222 to $ 1,081.

Suppose you cannot or do not want to pay the closing costs out of pocket, but instead agree to an interest rate of 3.7%. In that case, your payments would be only $ 49 a month less than your old mortgage.

Option 2: Include closing costs in the loan

Adding the closing costs to the new loan means adding them to the principal of the loan. While the lender may offer you the same interest rate as if you were paying the closing costs out of pocket, this option will increase your monthly payments and lower your overall savings.

Assume that under the same $ 250,000 mortgage scenario as above, you are adding the $ 5,000 closing cost to the new 3.2% mortgage. (Now borrow $ 255,000 instead of $ 250,000.) If you choose this option, you will reduce your monthly payments by $ 120 compared to your old mortgage. That’s $ 21 a month less than paying the closing costs out of pocket.

While all of these scenarios show that you can save some cash on your monthly payment by paying the closing costs out of pocket, you may not have that much cash on hand or have other uses for it. Another way to look at the situation is how long it takes for the money you save each month to add up to the amount you spent on closing costs. For example, if you cut your monthly payment by $ 141, as in the example above, it would take a little over 35 months, or about three years, for your savings to reach nearly $ 5,000.

Advantages and disadvantages of no-closing-cost refinancing

A no-closing cost refinance can have both advantages and disadvantages for most homeowners. Here are some to consider.

Advantages explained

• Refinancing without paying closing costs out of pocket. A no-closing-cost refinance allows you to keep your money for other uses.
• Disbursement of home equity. You can use a no closing cost refinance to pull equity out of your home that you can then use for repairs or other expenses. While you can do this with any type of cash-out refinancing, a no-close-up loan means you have more cash to spend.
• Lower interest rates can still save you money. Even if you pay a slightly higher interest rate on a refinance with no closing costs than if you paid those costs up front, the difference between your old and new loan interest rates can save you money over the life of the loan.

Disadvantages explained

• You do not avoid closing costs. A refinancing loan with no acquisition costs does not mean that these costs are completely eliminated; You just don’t pay them upfront.
• The monthly payments could be higher. Depending on the new loan term you have chosen and the interest rate you are interested in, your monthly installments for a non-binding refinancing loan can be higher than for your current loan.
• May take longer to break even. The break-even point represents the point at which any monies that you paid directly or indirectly for the closing costs will be recouped through interest savings on the loan.

The bottom line

For homeowners who want to refinance their mortgage without spending a lot of money, refinancing with no closing costs can be attractive. Whether a no-closing-cost refinancing makes sense for you can depend on a number of factors, including:

• How much money you want to save on interest
• The interest rates you can qualify for based on your credit and income
• How long do you want to stay in the house
• Whether you choose to pay a higher interest rate or incorporate the closing costs into the loan

If you are considering free refinancing or regular mortgage refinancing, take the time to shop around and compare the best mortgage rates. This can help you find the best home refinance loan terms.