The first thing you should do is read the fine print when you hear or see a lender advertising a refinance loan with no closing costs.
“In the refinance world when someone says there is such a thing as a no fee refinance or no-cost closing, it’s not true,” says Daniel Nunes, market leader at Movement Mortgage in Raleigh, N.C.. “Those costs have to go somewhere. They have to be captured somehow because everyone needs to be paid.”
“No-cost” probably has a different definition for the lenders than it does for you, he adds. It does mean that you won’t have any out-of-pocket costs at that moment. That can be a good thing for many people who haven’t saved enough for such fees. But the costs will come back to you to pay in one form or another. You aren’t getting away with some big discount or promotion.
Two Ways to Pay Closing Costs Besides Out-of-Pocket
The way that lenders recoup those costs vary from place to place, but there usually is just two primary ways you end up paying the costs.
“The lender can roll those costs into the new loan amount, if you meet all the guidelines,” Nunes says. “For instance, if you have $150,000 mortgage loan to refinance, and the closing costs would have been $5,000, then they put that $5,000 into the new refinance loan. You are still paying the costs, but they are spread out over the 30 years of the new loan.”
This type of no-cost closing has little effect on the interest rate. However, by putting the costs into the loan, you will be paying about $4.50 to $5.00 per month extra per $1,000 of the $5,000 in closing costs. Even though that doesn’t sound like a lot, it still adds up to more money you are putting out each month.
The second way that the money is recouped is through a lender’s credit, which means you’ll be getting a higher interest rate.
“Unfortunately, nothing in this world is free. And there is only so much margin and revenue in a loan for a lender. So, what the lender does is increase your interest rate to make up for the closing costs,” he says.
How much the interest rate goes up all depends on the loan amount. It can go up 3/8 to ½ percentage many times. On a 30-year loan, that could easily add anywhere from $50 to $100 a month more on your payment.
“Coming from 15 years of experience in mortgages, what I tend to find is that folks get really caught up in the interest rate. But 98 percent of the time, the interest rate is not the most important thing,” Nunes says. “You need to think about a lot of other things such as the need for private mortgage insurance, how long you will live in the house and the structure of the loan itself.”
Define Your Goals for the Refinance
There is a series of questions any good loan originator should ask a borrower seeking to get a refinance loan. The No. 1 question should be what goals that person is looking to attain. Sometimes if the borrower simply wants to get money out of the home’s equity through a refinance, then the lender might suggest an equity line of credit might be better.
“The mortgage industry is such a complicated, convoluted industry. It’s not a simple industry to understand if you are not in it,” he says. “The law does say that lenders have to say somewhere how those closing costs are actually captured. But it could be hidden on their website somewhere.”
So when a lender advertises that he/she is offering no-cost closings, this is when consumers can get the smoke and mirrors.
“By the time the borrower is sitting down with one of the originators, they aren’t going into details about how these costs are going to be captured,” he says. “Good originators will explain the options and give their opinion of a borrower’s best choice.”
Most of the people that Nunes sees refinancing these days are people who have existing FHA loans who want to drop their PMI or those whose home values have increased significantly the past few years. Refinancing has dropped off considerably.
But for those who want to refinance, the no-closing cost refinance might make sense especially if they don’t plan to live in their house for too many years. Just ask a lot of questions, understand where those costs are going to and whether or not it is a good deal for your own situation.
Refinance Your Mortgage With No Out-of-Pocket Costs
Having no cash on hand shouldn’t stop most people from refinancing. Most of the time, borrowers pay lender costs another way.
Refinances often pay for themselves considering the interest savings in the current rate environment.