Today I suggest we talk about the so-called “no-cost” refinancing. First of all, this commonly used name for a refinancing option one can find very useful under certain circumstances is in fact rather misleading, because:
- No-cost does not mean free from any costs;
- No-cost refinancing helps you only with the Non-Recurring Closing Costs;
- No-cost refinancing still leaves you to pay at least Property Taxes, Interest, and Insurance.
Now that you’ve been warned, let’s take a closer look and find out about the circumstances under which this option can be useful.
Any refinancing involves a number of fees charged by both the lender and third parties. The fees are rather numerous and can add up to quite a considerable amount. You can either pay it all yourself or opt for the “no-cost” alternative. In the latter case, the lender will pay most of the refinancing fees at the moment of the refinancing itself, but it is going to cost you a higher interest rate on your new loan. The interest rate on a loan resulting from no-cost refinancing is usually 0.250% – 0.500% higher than that on an equivalent borrower-paid-closing-fees loan. This is the lender’s way to return the money he actually lent (not gave!) you by paying the refinancing costs: he just bought you some negative points. The rate will be high enough for the lender to be able to recover the complete amount. The new loan may include prepayment penalties, as the lender wants to make sure, the money does get to be repaid. A true no-cost refinancing employs only the interest rate to return the money. Unlike a “no-cash” mortgage closing option, there should be no increase in the total amount borrowed on that account. It is very important to make sure that both you and the lender have a clear and agreed upon idea of how the refinancing fees are going to be repaid.
Even though you are the one to pay all the costs after all, I dare remind you, the lender’s one-time helping hand contribution at the refinancing will not cover all the settlement fees. Very likely, it will only take care of the non-recurring closing costs, such as the appraisal fee, the credit report, the lenders’ fees, the broker fees, the title insurance, the escrow fees and the recording fees. The non-recurring refinancing costs, such as the property and transfer taxes, the interest (the new loan’s interest from the day of closing to the first day of the following month and the interest on your old mortgage from the first of the month to the closing day), and homeowners insurance are still totally your responsibility.
The most important thing is to be aware that even no-cost refinancing calls for quite some of your cash anyway and results in a higher interest rate loan. Considering all this, I still believe that this type of refinancing can be much of assistance to borrowers who are willing to get rid of their current loan for some reason, but are short of cash to pay all the refinancing fees themselves. It’s true that they will need to invest some of their own funds into the process, but the amount will be considerably lower than the complete settlement costs.
The resulting high interest rate is a bit of a pain, though, as the monthly payments are higher, but it takes a while (the breakeven period) before it really starts eating your money. It is easy to estimate roughly how long this while will be in your particular case: look at the difference in your monthly payment for a no-cost loan vs. a loan with costs and then divide that difference into the amount of non-recurring closing costs that you would have to pay at closing. The result of this calculation is the number of months, during which the no-cost refinance loan is a sensible deal. If you have to keep this mortgage longer, it turns into a rather costly deal.
For that matter, no-cost refinancing is generally useful to people, who are not planning to stay in this particular mortgaged property for a period of time longer than the above mentioned break-even period.
Finally, if your fortune changes and instead of being short of cash you suddenly happen to have plenty of it, you can try to refinance again and attain more reasonable conditions. Mind the new refinancing costs and the possible prepayment penalties, though.
