How a No Cost Refinance Loan Really Works

no cost loan

You may have seen ads for a “no cost refi” loan lately, a mortgage program that promises no fees or out-of-pocket expenses when you refinance your existing mortgage.

While this type of offer is by no means a new concept, it’s definitely a subject worth visiting to ensure people understand what they’re getting when they choose a no cost refinance option.

What Is a No Cost Refinance?

A no cost refinance is essentially a loan transaction in which the lender or broker pays settlement costs, including typical lender fees such as processing and underwriting fees, the appraisal fee, and loan origination points, along with third party costs like title/escrow fees and so on.

You may be asking yourself how banks and lenders make up for the absence of fees that normally must be paid during a refinance (or purchase) transaction.

Well, assuming the lender actually pays your closings costs, doing so will bump up your interest rate, sometimes dramatically, in order to make up for the missing fees that are typically charged at closing.

No Cost Loan  = Higher Mortgage Rate

It’s a simple trade – pay nothing now, but pay more over the life of the loan in the form of a higher mortgage rate.

For some borrowers, a no cost loan is a necessity because they don’t have the required funds to pay all the fees at closing, but for others it’s a decision that will need to be made during the loan process.

Keep in mind that mortgage brokers can also set up a no cost loan for you, adjusting their yield-spread premium (commission) to the point where they make enough money to offset the fees associated with the loan.  *This is now accomplished by using a lender credit.

Tip: The terms of no cost loans will vary by lender. Some programs may cover ALL closing costs, while others may still charge you for certain third-party fees such as appraisal/inspection, title, escrow, and even mortgage points!  Be sure to pay attention to what fees are and are not covered.

For example, if a bank advertises a “no lender fees loan,” they will expect you to pay for third-party fees, along with property taxes, prepaid interest, and insurance.  Regardless, you can still attempt to negotiate a lower rate whether it’s no cost or no fee.

[How to Lower Your Closing Costs.]

Let’s look at an example of a typical no cost refinance program:

No cost refinance: 6.5% mortgage rate, NO fees.
Standard refinance: 6% mortgage rate, $7,500 in fees.

Imagine you’re able to qualify for a mortgage at an interest rate of 6% on a $500,000 loan, paying a point to the lender and another $2,500 in closing costs, totaling $7,500. While this may seem like a large upfront cost, the trade-off should be a lower interest rate.

With a typical no cost mortgage, you’ll cruise through the process without paying a dime at closing, but you may end up with an interest rate of 6.5% or higher for the very same loan.

Assuming you make the interest-only payment each month, you’ll pay an additional $200 a month, or roughly $2,400 more annually if you select the no cost option at an interest rate of 6.5%.

As you can see, it’s a case of pay less now, but a lot more over time.  You’re basically financing the costs you didn’t pay at closing, which will be more expensive in the long run.

Is a No Cost Refinance a Good Idea?

This is the point where you need to ask yourself what you plan to do with the property and the mortgage.

If you’re planning on moving or upgrading to a more expensive home in just a few years, or if you’re the type who refinances often, paying upfront costs for a lower interest rate will probably be a losing endeavor. For you, a no cost loan may actually be a good choice.

After all, there’s no reason you should pay for a lower interest rate if you’re only going to turn around and sell/refinance a few months/years later.  You’ll never realize the savings!

But if you plan to stay in the home for five or more years (or whenever the break-even point takes place), it would make sense to pay a little more upfront for future savings.  Why?  Well, that $200 discount each month might ease your budgeting woes in the future, and amount to some serious savings if you stick with the mortgage for the long haul.

Remember, no cost loans aren’t inherently good or bad. They aren’t a scam and they aren’t magic.  The money is either paid upfront or over time.  Their associated benefit or cost will really depend on your unique financial situation, what the fees are, and what the interest rate impact will be.  Make sure you do the math and compare options before signing on the dotted line.

Also watch out for banks that “bundle” your closing costs on top of your loan amount, increasing the size of your loan, effectively making it a “no-cash loan.”

Though you may avoid out-of-pocket expenses and upfront fees, these costs are not lender-paid, and the loan is not a true no cost loan.  You simply pay the fees over the life of the loan instead of at closing.  And you’re stuck with a higher loan amount to boot!  Not necessarily a great deal.

For the record, you can also get a no cost loan for a home purchase, though it might take a combination of a lender credit, a credit from your real estate agent, and seller concessions to make it all work.

Lastly, don’t forget to negotiate.  It might be best to ask the lender what their best rate is, then tell them you want a no cost option as well.  That way you can see what the difference is without showing your hand.  If you tell them you want the loan at no cost, you may never know how low the rate could have been.

Read more: Buying down your interest rate.



70 Comments

  1. Colin Robertson December 1, 2017 at 12:29 pm -

    LaVerne,

    Good question. Part of it has to do with the current state of your mortgage. In other words, if you can refinance and also lower your existing mortgage rate while getting the cash you need, it could be a win-win. But if you refinance only to get some small sum of money and make your mortgage more expensive in the process, it might defeat the purpose. It also depends on the financing terms of the remodel company. Another option is a home equity line or loan behind the first mortgage used to pay for the renovations that doesn’t disrupt the first, assuming you like where your current mortgage is.

  2. LaVerne December 1, 2017 at 11:48 am -

    Question

    Would is be better to refinance to pull money out for remodel or obtain separate financing from company doing the remodel?

  3. Colin Robertson November 3, 2017 at 8:11 pm -

    Stephanie,

    Generally, when it comes to underwriting stuff like that, they want to paper trail and document everything so it all adds up, and more importantly, makes sense. Perhaps if you can prove the difference in those child support and post-insurance child support deposit amounts with another document that details the cost and purpose of the insurance, it might be sufficient to the underwriter. But they all have their own modus operandi and comfort level. The loan officer might be able to communicate this to the underwriter to see what will work beforehand so you know in advance what you’ll need to get that approval. Good luck!

  4. Stephanie Sharpe November 2, 2017 at 12:54 pm -

    Hi Colin,
    My home is worth approx $237,000 (accord. to Zillow) I owe $90,863 on the 1st with a 3.125% adjustable rate and $30,927 on the HE with a 4.125% rate. My payment on the 1st is $572 & going up in Jan to $605. Payment on the HE is $315. I would like to refinance & combine the loans, pay off some debt ($16,500) get a low rate, & take out some money for renovations while keeping my house payment close to the same. My credit score’s are excellent (757, 754) I came close to getting approved through a credit union a year ago but they denied my refi at the last minute because my only source of income is maintenance/child support that at the time was going into a joint account with my ex husband. I set up an account in my name only & showed that history for 6 months (what they wanted). I went to reapply & they said no because the amount deposited didn’t match the amount in the divorce decree (he was deducting money from my check for kids insurance) Sorry for the long email but I’m recovering from a divorce where my ex handled the finances. First, am I dreaming to want all this? & second is it typical for the lender to want to see the specific maintenance/child support amount from the divorce decree deposited in my checking account for 6 months before they will revisit my application or should I look for another lender? I have a lot of health problems and am not able to work at this time & am wondering if that’s part of the problem. I have maintenance for another 4 years and have contacted a lawyer to look into applying for disability.

  5. Colin Robertson October 16, 2017 at 3:08 pm -

    Jennifer,

    Not sure how you’d be able to get $65k out if you currently owe $116k on a $136k property. I’m assuming it’s worth more and the $136k was your original loan balance? Anyway, the choice is really yours and depends on the interest rate of the student loans and what the new refinance rate would be on the rental. The downside with rentals is that the rates are higher than primary homes and it’s harder to get a higher-LTV loan. But it depends how high the LTV is, and with rates a lot lower than the mid-5s these days, it could be something to look at. Really just have to do the math, make a plan, and consider the alternatives and how they stack up. Also have to consider if you want to pay off the rental or take on more debt, though a shorter-term mortgage and lower rate may pay down the balance a lot quicker than the current setup. Good luck!

  6. Jennifer October 15, 2017 at 8:56 pm -

    Hi Colin,

    I want to refinance my mortgage on a rental property (I don’t own another home just had to move out of the state). My credit union would refinance because it’s a rental. I still owe $116k on the $136k on the 40 year mortgage at 5.375% but pay $350 extra a month on it with the rental income and still save money. I want to get $65k out to pay off my remaining student loans and have money for a down payment for a house in the state I’m now living in instead of continuing to pay $1850 a month in rent. Should I refi my house to do this or just continue to pay down my student loans and save money on my own to gather a down payment for another home? Keep in mind, I can’t save much while I’m paying off the student loan debt, I’m throwing money at it like a stripper on a pole. It’ll take me another 8 months to pay them off if I don’t refi.

  7. Colin Robertson September 15, 2017 at 9:43 am -

    Wenn,

    If you’re saying the lender delayed the closing, ideally they would cover the extension costs, but if some of the blame falls on you, the costs may also. Rates may have fallen since you first applied though, meaning it may be possible to let the lock expire and relock at today’s pricing, assuming they allow it, or apply elsewhere for better pricing.

  8. Wenn September 14, 2017 at 10:06 am -

    Colin:

    In the process of refinancing my mortgage from 4.5% to 4.125%. I currently owe $349K, with the refinance returning the loan to $358K. My question is: when the underwriter rejects the loan file due to questions on your credit report can this take up to 60 days (questions were concerning my student loan consolidation). Also, is this a way to boost the closing cost considering I have had several rate locks and the mortgage rate increase from 4.00 to 4.125 over this time period?

  9. Colin Robertson August 31, 2017 at 2:04 pm -

    Sal,

    It’s up to you. If you can handle the larger payment of the 15-year fixed and want to pay down your mortgage quicker, as you said, it can save you some money.

  10. sal August 31, 2017 at 11:49 am -

    my mortgage lender is saying it will go further down so no need to spend money on closing now, is that a good idea, when I calculated looks like we will save $4000 over the 10 years going with lower interest rate and paying the closing costs. What do you think?

  11. Colin Robertson August 31, 2017 at 11:14 am -

    Sal,

    Basically try to figure out your breakeven point where the $2,000 costs are recouped via the lower payment attached to the 2.875% rate. If it’s well before 10 years, it may be the better deal for you, despite the upfront out-of-pocket costs.

  12. sal August 31, 2017 at 11:06 am -

    Hi,

    We just closed the house 6 months ago at 4.15 % interest rate for 30 years fixed on a $450000 house with 10% down.

    My mortgage broker called and said we can do zero cost refinancing for 3.125 for 15 years fixed

    or

    2.875% for 15 years fixed with closing cost which he says will be approximately $2000. We have about $395000 loan left.

    We are planning to stay in this house for at least 10 years.

    Please advice which is better no cost refinancing at higher rate or closing cost at lower rate.

  13. Colin Robertson July 7, 2017 at 12:32 pm -

    Christine,

    You could shop around and see if other banks/lenders can beat your current rate and do so with little or no closing costs. A 15-year rate should be lower than a 30-year. Typically, existing lenders don’t offer very good refinance deals unless rates have fallen substantially, but outside banks are generally happy to swoop in and offer better.

  14. Colin Robertson July 7, 2017 at 12:05 pm -

    Cathy,

    It depends on the total cost of the monthly payment (including mortgage insurance) and what your goal is with the loan…e.g. lower payment or pay off mortgage faster…

  15. christine July 7, 2017 at 8:50 am -

    Hi, I currently have 25 years left on a 30 year mortgage, 3.75% APR. I spoke with my existing mortgage company today about refinancing to a 15 year conventional loan to get rid of mortgage insurance on my FHA loan. She said that my interest rate would still be 3.75% and I would have around $2200.00 in closing costs. Is this wise, or just wait for the PMI to drop off and go with it? I already pay an extra $150 to principle a month, so the difference in payment would only be $8 a month extra. Thanks

  16. Cathy June 29, 2017 at 3:33 pm -

    Does it make sense for us to refinance from our current FHA loan @ 3.625 rate to a “no cost” conventional loan @ 4.25-4.375 rate?

  17. Colin Robertson June 29, 2017 at 9:06 am -

    Kruz,

    Hmm, might be listed there in case there is in fact an appraisal required and as a safety measure for him to disclose it upfront. That being said, he might be right that it won’t be ordered, but may not be 100% sure.

  18. Kruz June 28, 2017 at 12:39 pm -

    Hi Colin,
    I have started process of refinance with an online broker at 2.74% interest rate for 15 yrs. balance on my current loan is 272K and it’s for 30 yrs.

    Lender has provided me the loan estimate disclosure with fees. Some fees are borrower to lender and some are borrower to third party (such as Appraisal, etc). Me and broker talked about low cost and he and I agreed that I don’t need to have an appraisal. Now if I had an appraisal I would have paid that cost upfront. I haven’t paid any cost for appraisal so far. However, he gave me loan estimate disclosure which has appraisal fee mentioned with all other costs. I asked him about it and he said it will be removed at later point once we are close to finalize everything.

    My question is how much trust I can put in his words? Should I trust what he is saying and wait for final figures or should I fight from now to get that fee line item be removed from the estimate?

    Note: one thing is sure there won’t be any appraisal happening that I know for sure.

    Thanks Kruz.

  19. Colin Robertson June 27, 2017 at 12:34 pm -

    Steven,

    It’s up to you…obviously the monthly payment will go way down because you’re starting a fresh 30-year term with a small loan balance…the downside is you’ll pay a lot more interest over the next three decades if you refinance and keep that new loan for a while. So it’s your decision if you want payment relief now or interest relief.

  20. Steven June 26, 2017 at 3:27 pm -

    Hi Colin,
    We have a 3.75 %, 15 yr. mortgage with a current balance of $255,000 with 7.5 years left. The home value is approx. $650,000+. Current monthly payment is $2650, we are entertaining a thought of a no-cost refi to lower our payments. We have an offer of 30 yr. mortgage that will decrease our payment by $1000/mo, with no prepayment penalties..

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