You have likely heard of no closing cost refinance loans by now. They have always been around, but have increased in popularity recently. The spike in interest is likely due to the lack of savings many borrowers have. With the downturn in the economy, it makes sense that people have less money to pay for closing costs. This should not deter you from refinancing if you have a goal in mind. However, you must realize the trade-off you make when you opt for no closing costs. As we know, nothing in life is free. You pay for the closing costs in your interest rate, in other words, for the life of the loan.
The Difference in The Two Options
You have two options – pay your closing costs now or let the lender pay them and take the higher rate. How do the options differ? Take a look:
- When you pay the closing costs now, you have to come up with the total at one time. Let’s say your closing costs equal $5,000. This means you need $5,000 in liquid funds that the lender can verify. You cannot ask someone to borrow $5,000 and stuff the money in your account 2 months before you apply for the loan; you must have the money already. You must also show that the money is yours, whether from your income, a windfall, or some other trackable source.
- When you opt for a no closing cost refinance, the lender waives the closing fees. In exchange, though, they charge you a higher interest rate. Usually lenders charge ½ point higher, but every lender differs. Because you pay interest over the life of the loan, you pay the higher rate for the next 15, 20, or 30-years. While 0.5% might not seem like a lot, it can add up over the years.
Let’s look at a 30-year loan with a 5% interest rate for the borrower paying closing costs and a 5.5% interest rate for the borrower taking a no closing cost loan. Assuming all things equal on a $200,000 loan, the payments would look like:
- 5% interest rate payment = $1,074
- 5% interest rate payment = $1,136
The higher interest rate means $62 more per month. While $62 does not seem like a lot, when you look at it over the life of the 30-year loan, it equals $22,320! Suddenly coming up with $5,000 for closing might not seem so bad. Of course, if you know you will pay the loan off sooner, whether by making extra payments or paying the loan off in full because you will move, you will not pay that much extra in interest.
Paying Some of the Fees in a No Closing Cost Refinance
Not all lenders allow you to pay zero closing costs at the table, though. Some require you to cover the third party fees. This typically includes appraisal and title fees. These fees can add up to several thousand dollars, though. If you had to come up with some of the fees and still pay the higher interest rate, it might not make any sense for you to take the no-closing-cost refinance. The only time it would make sense is if you know you will move within the next few years. Keeping the same interest rates as above, let’s say you know you will move in 2 years. This means you will pay $1,488 in extra interest over the 5% rate. If title and appraisal costs were $2,000, the loan would cost you a total of $3,488 before you pay it off. This is less than the $5,000, so taking the no-closing-cost loan would make sense in this case.
Basically, what you need to determine before considering a no closing costs refinance is when you will move. Even if you do not see yourself moving, consider your patterns for refinancing. Do you refinance often? This is the same as moving because you constantly pay off your loan. In these cases, it may pay to take the no closing cost loan. However, if you know you are in it for the long haul, take the lower interest rate; there is no reason to give the bank more money in interest than they need. Of course, this requires careful planning on your part, as you need to save up the money for the closing costs. Your due diligence will pay off in the end, though.