What is a No-Cost Refinance?

I know what you’re thinking: “Didn’t you just buy your place?”

Yes! And I’m already talking about refinancing.

I blame our mortgage broker.

Mortgage rates are down!

Out of the blue our broker emailed Ben and me telling us that interest rates have gone down, and we should think about refinancing for a lower rate.

Despite all of the fears at the beginning of the year that interest rates would continue to go up, they have made their way down again.  According to Bankrate.com, the current benchmark 30-year mortgage rate is at 4.27%, when one year ago it was 4.72%.  (Either one is still pretty low historically.)

We got our current mortgage 5%, when mortgage rates were a little higher at the beginning of the year. Our rate also included an increase for lender paid private mortgage insurance and closing credits from the lender. 

The new rate would be 4.625%, and she sweetened the deal by saying they would pay all of the closing costs.  She referred to the process as a no-cost refinance.

As you can assume, this proposal gave me pause. First, we get a lower interest rate, which will decrease our monthly payment. Second, the lower interest rate will save us tens of thousands of dollars over the life of our loan. And third, we don’t have to pay for the privilege of doing it.

So what is the catch?

No such thing as a no-cost refinance

Turns out that a no-cost refinance isn’t really “no cost” at all. Going through the application paperwork, I see just how many costs exist: an appraisal fee, a fee for someone to review the appraisal, credit report fee, title services fee, recording fee, and on and on. Instead of us having to pay these fees out of pocket, our lender lumped in the costs into an increased interest rate of the loan.  

Lenders can also construct a no-cost refi by simply adding the closing costs to the mortgage. For example, a borrower with a $300,000 30-year loan at 6%, may refinance for $305,000 at 5%. 

In short, what they really mean by no-cost, is no out-of-pocket costs.

Our broker was offering us 4.62%, when the benchmark rate is 4.27%. Theoretically we should be getting the best rate out there, since Ben and I both have excellent credit.

The refi may still be a good deal despite paying the fees over time

The tradeoff between paying the closing costs up front or over the life of the loan depends on how long we will be in this home or loan. If we are going to do either for a while, it makes more sense to pay the closing costs up front and get the lower rate (it’s cheaper over the life of the loan). If we are going to sell or refinance in a few years, we won’t get the benefit of the lower interest rate.

I’m betting, given this is our first home and we are already refinancing three months in, it’s a better deal to put the costs in the higher interest rate. Regardless, we will still get a lower rate and save money compared to the loan we have currently.

The main hassle has been gathering the loan documentation again.  We need more bank statements, paystubs, copies of licenses, etc. It’s a bit of a time suck but well worth the potential savings.

So next time you’re approached by a broker with a no-cost refi proposal, go into the transaction with eyes wide open. There’s no such thing as a no-cost refi. You either pay the cost up front or over time.