Refinancing your home to a better interest rate may save you lots of money over time, but many homeowners struggle with how to pay the upfront fees. One solution is a no-cost refinance–a term that refers to a number of ways the closing costs can be bundled into your refinance loan. While no-cost refinancing options do not require the borrower to pay cash for refinancing a home, the costs of refinancing a mortgage are still there.
Is No-Cost Refinancing Possible?
Mortgage refinancing always carries at least a little cost. The costs vary from place to place and lender to lender, which is why consumers should always compare offers from several lenders. Typically, refinancing your home costs 3% to 6% of the mortgage.
A no-cost refinance allows borrowers to avoid paying upfront costs for a new home loan. Typically, this can be accomplished in two different ways:
- The lender covers the closing costs themselves, but charges you a slightly higher interest rate (perhaps 0.5 or 1% higher than the current market rate) in order to recoup those costs. You pay that higher interest rate as long as you have that home loan.
- The lender wraps all refinancing costs into the loan. The home refinance costs become part of your principal balance, so you end up paying the fees with interest over the life of the home loan. For example, if you have a $200,000 loan, a home refinance could incur $6,000 in closing costs. If you choose to wrap those costs into your home loan when refinancing, your new balance would be $206,000.
Most borrowers choose to wrap their costs into the loan in order to avoid reducing their bank balance with closing costs. When you gather refinancing information, make sure you ask each lender for a comparison of the principal, interest rate, monthly payments, and any fees for a no-cost refinance as well as a refinance in which you pay the costs yourself at closing.
Some lenders require a prepayment penalty if they have rolled your closing costs into the loan. Make sure you check the fees and penalties of any home loan.
To determine if a refinance is advantageous for you, you can ask your lender to help you estimate the break-even period when the costs of refinancing your home are fully recouped by your savings. You can also do the calculation yourself with the help of an online mortgage refinancing calculator that compares your current loan with other mortgage loans.
Interest rates remain low enough that many homeowners stand to save by refinancing. As long as you do your homework, closing costs don’t have to stand in your way.