Beware the “No-Cost” Mortgage Refinance

As a followup to last week’s post about finding the best mortgage rates, I just wanted to remind you that there is no such thing as a free lunch. I mention this because those of you that are in the market for a new mortgage are likely to be confronted by offers for a “no-cost” refinance. While this isn’t necessarily a bad thing, it’s important to know what you’re getting into.

What’s a “no-cost” mortgage refinance?

A “no-cost” refinance is one in which the lender or broker covers the closing costs on your new mortgage. Depending on where you live, you can expect to pay 2-3% of the loan amount when closing a typical mortgage, so this is a great deal. Right? Well…

The reason I keep putting the term “no-cost” in quotes is because there actually is a cost — you just don’t typically see it. In other words, the lender doesn’t eliminate the costs, they simply convert them into another form. In most cases, this means that you’ll wind up paying a higher interest rate.

It works like this… Just as you can buy points to reduce your mortgage rate, you can increase your mortgage rate in return for negative points. Each point is equal to 1% of the loan amount. By accepting a higher than market rate on your loan, you can generate cash back that lender can use to cover the closing costs.

Clearly, this approach is most beneficial to those with a short time horizon, as they’ll enjoy the upfront cost savings without having to live with that higher rate for very long. If you decide that the “no-cost” option is best for you, be sure to get a full rundown of the costs that are covered so you can make a meaningful comparison across lenders — not everyone covers all the same things.

“No-cash” is not the same as “no-cost”

Perhaps the biggest mistake that you can make when shopping for a “no-cost” refinance is to wind up with a “no-cash” deal instead. While the names sound very similar, these are very, very different products. With a “no-cash” refinance, the closing costs are rolled into the balance of the new loan.

Because there aren’t any negative points involved with a “no-cash” refinance, the rate will likely appear more competitive on a “no-cost” refinance. Unfortunately, you’ll wind up paying the fees yourself over time plus interest.

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  36. Anonymous

    I have 7 years left on a 15 year mortgage at 4.75%. Is it worth my while to refinance? I don’t want to extend the term; I would want to make the same payment as I do now and put the extra towards principal, so the term would be the same as what I have left. The advantage would be paying less interest and also having flexibility in the event of income loss. My current loan is with a large bank that has been in the news for mortgage shenanigans. Can they be trusted to live up to a “no prepayment penalties” promise?

  37. Anonymous

    Tanya, who is your broker? I would like to do a no-cost refinancing on a condo I bought over a year ago. You reduced your monthly payments by $650? Wow! 0 points and 0 closing costs makes the duration of living in your current place irrelevant because if you decide to move a year or two later, you need not have to factor in the amount you paid in points and closing fees since you paid nothing.

  38. Anonymous

    I recently refinanced a$720,000 loan from 5% to 4.25% 30 year fixed. There were absolutely no charges to refinance, the loan amount remained the same, and my monthly payments are reduced by $450 a month. And two weeks ago I received another no-cost refinance offer at 3.75% 30 year fixed, and I am already in the final stage of having the loan transferred to a different bank. Again, nothing was added to my loan, and I am reducing my monthly payments by $200.00 a month. It is possible in today’s market. One should still be cautios, of course. I was lucky to have worked with decent and honest brokers. Also, we purchased the house less than two years ago, so refinancing at 30 year loan again isn’t going to affect us. We also plan to live in this house for a very long time.

  39. Anonymous

    I recently refinanced a$720,000 loan from 5% to 4.25% 30 year fixed. There were absolutely no charges to refinance, the loan amount remained the same, and my monthly payments are reduced by $450 a month. And two weeks ago I received another no-cost refinance offer at 3.75% 30 year fixed, and I am already in the final stage of having the loan transferred to a different bank. Again, nothing was added to my loan, and I am reducing my monthly payments by $200.00 a month. It is possible in today’s market. One should still be cautios, of course. I was lucky to have worked with decent and honest brokers.

  40. Anonymous

    Well, duh. One can’t really expect people to work for free and companies to take on the risk of refinancing folks for no compensation. That’s not evil, that’s just commerce. As the author says, a no-cost refi is still a smart play if your new rate is lower than your old one; there is no break-even period so those unsure of their time-frame can still lower their rate and payments. If you know you’ll be there longer than of course you should probably buy your rate down. A great calculator from shows the difference between all three ways of paying for a refinance and how they affect you. It’s called the Tri-refi calculator.

  41. Anonymous

    Rosa has the right idea and the original post mentioned this as well. Look at the total cost over the lifetime of the loan. Many loan offers tout saving money by lowering monthly payments but ignore the overall cost.

    In business I often have customers wanting to cut costs. In their mind this means a lower price or longer terms which is actually shifting costs, much like the no cost, nocash examples. Removing costs like home inspections, title searchs etc. is what you are trying to do. Home Equity loans though not lines of credit tend to be lower cost options. For a refi if you have already done title searchs and other things there is no reason to pay for them again.

  42. Anonymous

    If you’re planning on paying off the mortgage (instead of using any monthly savings for something else) I think the total lifetime cost is more important than the break-even point.

  43. Anonymous

    I would think that these days your credit would have to be absolutly perfect to get a no cost re-fi.

    I am hearing brokers are swampped right now with re-fi’s lets hope this doesn’t lead to another housing problem

  44. Nickel

    ckstevenson & Kerri: In the example you give, there’s not much downside. Refinancing resets the clock on your mortgage, but if you’re less than a year in, that’s not a big problem. While this may be a good option, however, you have to ask yourself if this is the best option. If you plan to be in your house for the long haul, then you might be better of paying the closing costs yourself and getting an even lower rate.

    What really matters here is the breakeven point. If it will take too long to recover your costs with the lower rate, then the no-cost refinance is a great option. Otherwise, you should really think about biting the bullet and paying the costs yourself.

    Of course, the other thing to be sure of is that this is a true no-cost refinance, and not a no-cash refinance (some brokers play it fast and loose with the terminology, so be specific when asking questions).

    Bottom line: There’s nothing inherently wrong with a no-cost refinance as long as you understand what it’s all about and are sure that it’s the best option given your circumstances.

  45. Anonymous

    Interested in any arguments for/against ckstevenson’s comment since I’m almost in that exact situation and I’ve considered a “no cost” loan myself…

  46. Anonymous

    A very basic example:

    I have a 30 year fixed with 29 years left at 5%, I get offered a “no cost” refi for let’s say 4.75% as a 30 year fixed.

    Why wouldn’t I take it?

  47. Anonymous

    Tanstaafl is a great principle to always keep in the back of your mind, but in today’s lending market “no-cost” refinancing may be a great option. I say this because in most cases rates today are likely to be much lower than what some one already has. Now, if we are talking about a “normal” market everything you said is spot on.

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