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Does A No Closing Cost Refinance Make Sense?

Refinancing your mortgage to a lower rate is a smart move if you’re looking to lower your monthly payments or to save on interest but the closing costs can be an obstacle for some homeowners. Closing costs typically run several thousand dollars which can put a serious pinch on your wallet. A refinance with no closing costs is an option if you’re strapped for cash but it’s not right for everyone. If you’re thinking of taking the no closing cost refinance route, it pays to understand the pros and cons.

Related: Refinance Closing Cost Calculator

How It Works

Refinancing typically involves a number of fees, including the application fee, loan origination fees, title fees, administrative fees and appraisal fees. As the homeowner, you’re responsible for covering these costs before the refinance is complete. When you opt for a refinance with zero closing costs, you’re still responsible for these costs but the lender doesn’t require you to pay for them up front.

Typically, there are two ways a no cost refinance loan can work. In the first scenario, the lender simply adds in the closing costs, taxes and insurance to your existing mortgage and refinances it at the new rate. With this option you’re still paying the closing costs but you’re able to spread it out over the life of the loan.

Related Article: The Costs and Benefits of Refinancing

The other choice lenders have is to eliminate the closing costs entirely but charge you a slightly higher rate. For example, you may be offered a refinance rate of 3.45% if you pay the closing costs and a rate of 3.85% if you don’t. You don’t have to cough up the extra cash at closing and your lender is able to recoup the closing costs by charging you slightly more in interest.

Which Option is Better?

No Closing Cost Refinance

When you’re considering a no closing cost loan, you need to choose the option that best fits your refinancing goals. For instance, is it more important to lower your monthly payment or pare down your interest rate? Building the closing costs into the new loan may qualify you for a lower rate but it could potentially bump up your mortgage payments. Forgoing the costs for a slightly higher rate may keep your payments low but it could make your home more expensive in the long run.

Related: Should I Refinance?

Running the numbers can give you an idea of how much you’ll save. For example, let’s say you owe $250,000 on your current mortgage with an interest rate of 5.5%. The closing costs are $5,000 but your lender offers to tack them on to your existing loan. You end up refinancing $255,000 at a rate of 4.25%, which lowers your payment by approximately $160 a month.

If you decide to pay a slightly higher rate instead of adding in the closing costs to your mortgage, the results are a little different. If your lender bumps the rate up to 4.75% you’ll only be saving about $120 a month on your payments. Your principal balance won’t increase but you’ll end up paying more in interest over the life of the loan.

When Does a No Closing Cost Loan Make Sense?

No Closing Cost Refinance

Even though a no closing cost loan can potentially be a more expensive refinance option, there are some situations where it’s the best choice for the homeowner. If you’re not planning to stay in the home long-term a no closing cost refinance may be a good bet. The higher your rate is, the longer it’ll take for you to break even but that may not be a concern if you don’t think you’ll stay longer than five years.

If you think you’ll refinance again at some point in the future, taking the no closing cost option is a smart choice if you’re looking to free up some cash in your budget. Using the money you’re saving on closing costs to fund some home improvement projects can give your equity a boost and add up to major savings when it’s time to refinance again.

Related Article: 3 Ways to Prep for Refinancing

When you’re considering a refinance, it’s easy to focus on the small details but you really need to pay attention to the bigger picture. Taking out a no closing cost refinance loan may yield some immediate out-of-pocket savings but it could end up being much more expensive in the long run.

Related Article: 5 Cheap and Easy Ways to Boost Your Home’s Value

Photo Credit: © iStock.com/Courtney Keating, © iStock.com/ChristianChan, © iStock.com/Stephan Zabel

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Rebecca Lake Rebecca has been writing about the nuts and bolts of personal finance since 2009. Her work has appeared on a number of popular finance sites, including the Quickbooks/Intuit small business blog and Money Crashers. As a homeschooling mom of two, she's always looking for ways to make the most of every dollar.

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