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No cost refinance
The no-free-lunch rule applies to mortgages, even those that call themselves no cost mortgage refinances.
Win the lottery and you have a choice: receive your prize money all at once or in a series of payments. You have a similar choice when you refinance your home: pay your closing costs up front or throughout the life of the loan.
No cost refinance explained
They're called no cost refinances, no fee refinances, and no cost mortgage refinances; all these names refer to the same thing, a mortgage refinance that has minimal closing costs. To close a traditional refinance mortgage, you'd have to pay for things like the title search, title insurance, courier fees, flood certification fees, recording fees, attorney's fees, etc. Even on a no-points loan, the closing and settlement costs can add up to more than a thousand dollars. On a no cost mortgage refinance, the lender foots the bill for these expenses without increasing your loan balance.
There will be some costs, however, that the lender won't cover. Typically, a no cost refinance lender won't pay amounts associated with prepaid homeowners' insurance, escrow fees, prepayment penalties on the old mortgage, or prepaid interest on the new one. Prepaid interest arises when the new mortgage closes on a day other than the first of the month; you'll have to pay for the interest that will accrue between the closing date and the date of your first mortgage payment.
At first glance, the no cost refinance mortgage seems like it's offering you free money-until you start comparing rates. In reality, you'll be charged a higher interest rate on the no cost loan; the increased finance charges, over time, basically compensate the lender for paying the closing costs on your behalf.
Evaluating a no cost refinance
The no cost refinance can be a good deal if you pay off or refinance the loan in a few years. To find out for sure, compare the payments on a traditional refinance with those of a no fee refinance. At some point, the higher cost of the no fee refinance will add up to more than what you would've paid in upfront closing costs. In the simplest sense, if you pay off the loan before that breakeven point, the no fee mortgage saves you money; otherwise, it costs you more.
To make a more exact evaluation, consider the added tax benefits of the higher interest rate, as well as how your savings income might be affected by paying the closing costs upfront.
Finally, there may be reasons why a no fee refinance is preferable, even if it does end up costing more. If the rate is still competitive, for example, and you plan to keep your cash invested elsewhere, the no fee loan might be ideal. Or perhaps you're planning to win the lottery and pay off the mortgage immediately. That's not a good basis for financial decision-making-but it doesn't hurt to dream.
Browse Mortgage Rates
Renovation Refinance Loans
Need to renovate your home but don't have the cash or are low on home equity? There's a mortgage refinance loan you might not be aware of that could be just the ticket - the renovation refinance loan. This hot new lending product could be the best way to renovate your new home without breaking your personal piggy bank in the process
Cash-out Refinancing to Pay For College
A cash-out refinancing can help you pay for your child's education, with reasonable terms. The summer after your child's graduation from high school could be the perfect time to adjust your old mortgage.
Refinance with a fixed-rate interest only mortgage
Rising interest rates tend to restrict the lending options of homeowners. When rates spike, 15- and 30- year loans become less attractive. Things get particularly bad when the gap between long-term and short-term rates narrows; this results in higher rates for Adjustable Rate Mortgages (ARMs), which are known for great introductory rates. With lending options limited, cash-strapped homeowners may turn to another option: The fixed-rate interest only mortgage.
Cash-Out Refinancing Makes a Comeback
Back during the real estate bubble of 2007 when people were using their homes like giant ATM machines, cash-out refinancing was an easy way to pull some equity out of a home to finance vacations, home repairs, cars and pay off credit cards.