What borrower hasn’t heard about the no cost refinance, the no fee refinance, or the free refinance? The terminology may differ, but it’s all the same thing. A way for homeowners to refinance with zero or minimal closing costs paid by the borrower. Typical closing costs include title search fees, title insurance, courier fees, flood certification fees, recording fees, attorney’s fees, etc. Even on a loan with no points and no origination fees, closing and settlement costs can add up to over a couple thousand dollars – depending on the loan amount.
For a no cost refinance, the lender covers these costs without having to add them to the new loan amount.
It is important to note which items are classified as closing costs and what items are prepaid expenses. The lender is not going to pay for prepaids. What are prepaids? These are the expenses associated with your real estate taxes, homeowners insurance, interest, prepayment penalties, etc. If you take a look at a Good Faith Estimate, you will see a total for closing costs and a separate total for prepaids. In the typical case, prepaids are expenses you would have paid even if you did not refinance. So, if you kept your current loan, you would still have to pay your insurance and taxes. The lender will also not pay prepaid interest - this is interest due when the new mortgage closes on a day other than the first of the month. The borrower will have to pay for the interest that will accrue between the closing date and the date of the first mortgage payment.
For FHA loans, the lender will not pay the cost of the FHA upfront mortgage insurance premium.
At first glance, the no cost refinance seems worth considering. But is it really no cost? Technically, no. When the lender pays the closing costs, the borrower will get a higher interest rate. The higher rate compensates the lender for paying the costs on your behalf. There’s no free dinner. Otherwise, wouldn’t everyone choose the no cost option?
There are some cases when the lender cannot do a no cost refinance. This happens when there is insufficient profit in the loan at any reasonable interest rate that would allow the lender to pay the costs. With the way loans are priced now, this is much more likely to happen now than 2 years ago.
Borrowers who are concerned about their new loan amount being too high should consider coming to closing with a check for the new escrows or even more. Though it’s not very common, it is a solution to avoid the increased loan size.
Ask me to do an analysis of the numbers to see if a no cost refinance can work for you. If you plan to be in your home for a long period of time, in most cases, a no cost refinance is not the smartest choice.
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{ 3 comments… read them below or add one }
Hello,
I have a current $488K interest only mortgage at a rate of 5.5 APR. I have 3 years left on the 7 year IO loan before the fixed rate adjusts. I only think I will be in my home for another 2-4 years at the most. That is why I am thinking of doing a refi for a lower rate (hopefully). Also, I only have about 10-15% equity due to the reduction in the value of the home because of the down market. Please advise if you think it would be a good idea to seek a refi at this time, and what you think the current rate would be. I don’t mind doing another IO loan or conventional principal + interest loan. FYI: my credit score is ~780 and I have good income (~250K/year)
@Majed Rafeh – Sorry for the delay in responding. Your comment was dropped in spam. Generally speaking, you will need 20% equity in order to refi at the best rates. HOWEVER, if you currently have a Fannie Mae or Freddie Mac loan, and you have the 10/15% equity, you can get by w/o the 20%.
The market in interest only loans is not what it used to be. Nothing is the same in mortgages any longer. Impossible to quote rates based on the little info available. Given the variables in your situation (i.e., interest only, moving, equity), I suggest you make a phone call to a loan professional you trust so he/she can properly evaluate everything.
when we applied for a interest only loan this summer, the mortgage company wanted us to have a boatload of money in the bank. don’t recall how much, but it was a huge amount. is this the same everywhere? that’s what they told us.