Refinancing a mortgage costs money. The lender needs to pay third parties for various services as well as use its own resources to fund your loan. In order to compensate for the costs involved, they charge you closing costs. Because there is not a seller to help pay these costs as there is with a purchase, you might feel like you have to front the costs yourself. The good news is you can obtain a no cost mortgage even with a refinance. Because closing costs can total in the thousands of dollar range, it is good to look into your options. The tradeoff with a no cost loan, however, is a higher interest rate. What you need to determine is if it makes sense for you to take the no-cost loan.
Applying for the No Cost Mortgage
If you wish to obtain a no cost mortgage for your refinance, you must let the lender know. This means not only applying for the loan but also requesting the no closing cost loan. Not every lender will offer this type of program, so you may have to shop around. Even lenders who offer the no cost loan might have specific requirements in order for you to qualify. For example, they do not want to provide this type of loan to a borrower who has a high risk of default or to one who plans to move quickly. The idea is for the lender to recoup the closing costs with the slightly higher interest rate they charge. If you do not make your payments, the lender will lose out not only on the interest but on the money they fronted you for the closing costs too.
Negotiating the Interest Rate
The next step is to negotiate the interest rate. You can do this with any type of loan, including refinances where you pay the closing costs yourself. Every lender has different parameters they must meet and different levels of flexibility in terms of the interest rate. It is up to you to negotiate how much they charge you. If one particular lender cannot lower the interest rate they offer, consider shopping around. Typically, applying with 3 or 4 lenders at the same time will net you the greatest results. This allows you to compare “apples to apples” while ensuring you receive the best deal on your interest rate as well as your closing costs.
In general, a lender will charge you between 0.25 and 0.5% in order to pay your closing costs for you. For example, if a lender can provide you with a 4.0% interest rate on a standard loan where you pay the closing costs, they will likely charge you between 4.25 and 4.5% for a no closing cost mortgage. Again, every lender differs in what they can afford to offer so you should shop around to see which lender offers you the best deal.
Does it Make Sense To Take a No Closing Cost Mortgage?
The next step is to determine if it makes sense for you to take the higher interest rate on a no closing cost mortgage. The rule of thumb is if you plan to stay in the home for less than 5 years, then it makes sense to take the higher interest rate. This is because it generally takes 5 years to pay off the closing costs from the refinance. If you do not plan to stay in the home for more than 5 years, refinancing does not make sense because you will not be in the home long enough to see the savings. If you let the lender pay the closing costs, you will pay less in interest charges over the next 60 months than you would if you paid the closing costs outright. The sooner you move, the more you benefit, but you can still reap savings by not paying any closing costs.
Bringing Money to the Closing
Typically, even with a no closing cost mortgage, money still needs to be brought to the table. The lender can cover the standard closing costs, such as origination fees, underwriting, process, and even closing fees. What they cannot cover is costs, which include real estate taxes and per diem interest incurred on the loan. You might also have to bring money to fund your escrow account and/or pay currently due taxes or homeowner’s insurance. This will depend on the time of year you close on your mortgage and the due dates for each of these items. Talking with the lender ahead of time can help you determine if you need to pay these items and how much it will cost you.
Obtaining a no cost mortgage for a refinance can be a great way to lower your interest rate or change the term of your loan without costing you a lot of money up front. If you know you plan to stay in your home for the long-term, however, it might not be the best choice. In this case, you would be stuck with the higher interest rate for the term of the loan. If the term is 30 years, you end up paying a lot of extra interest, which you could have saved if you paid the closing costs upfront. Knowing your plans as best you can is the best way to help you determine which type of refinancing is right for you.
