Refinancing overview -> No-cost loans

No-cost loans

It is often possible to refinance and pay little or no closing costs,
at the cost of a slightly higher interest rate.

In a ‘no-cost’ loan, the lender pays all of the non-recurring closing costs. These costs are not rolled into the loan amount, but are credited back to you by the lender. However, these loans always have a higher interest rate and payment than a loan in which you pay the closing costs.

Consider a no-cost loan if: Avoid a no-cost loan if:
  • You either cannot or do not want to spend the money to pay closing costs. You may need the maximum amount of cash from a cash-out refinance.
  • You are only going to have the mortgage for a relatively short time. As a general rule, the savings you get from having the lender pay your closing costs are eaten up by the higher monthly payment of a no-cost loan in about five years. If you plan to pay off the mortgage within five years – from a sale of the property, a refinance, or a liquidity event that provides funds to pay off the mortgage – a no-cost loan is definitely a smart option.
  • You know you are going to refinance within three years. You might be completing a remodel or planning to put a child through college and intend to refinance again within three years even if rates have risen since the time you did the no-cost loan.
  • You believe interest rates will fall. I would be careful of this one: very, very smart people in the world of global finance often get interest rate calls wrong. However, if interest rates fall within a few years after you get a no-cost loan, and you are financially in a position to refinance, you will save money with a no-cost loan.
  • You have the money to pay closing costs and it makes financial sense to take the lower interest rate.
  • You are certain that you will keep your mortgage for more than three to five years.

When comparing two loans with the same loan amount, and where the only difference is that one is no-cost at a slightly higher interest rate, check the difference in monthly payments to find out how much the ‘no-cost’ loan is going to cost you on a monthly basis, and over the time you think you will have the loan. If the lender is willing to credit you $3,500 in closing costs, but your monthly payment is going to increase by $100, over ten years your $3,500 ‘saving’ is going to end up costing you $12,000 in the form of a higher mortgage payment.

Another option if you don’t want to pay the closing costs upfront is to finance those closing costs by increasing your loan amount rather than getting a no-cost loan with a higher interest rate. If you keep your loan for more than 3-5 years, this will be a less expensive option than a no-cost loan. Check with your lender.