Mortgage Refinance with No Closing Costs: It's a Trade-off

The idea of getting a mortgage loan with no closing costs almost sounds too good to be true. But it's actually possible. Borrowers often use this strategy to reduce their upfront costs, particularly when refinancing a home loan. In this tutorial, we will examine the pros and cons of no-closing-cost mortgages in general, and refinance strategies in particular.

As always, we will start with some basic definitions:

• Mortgage refinance — This is when you replace your existing home loan with a new one. People refinance their mortgages for several reasons. Most homeowners do it to secure a lower interest rate on the new loan, thereby saving money over time. People also refinance to switch from an adjustable to a fixed-rate mortgage, to shorten the term or payback period, and to convert equity into cash.
• Closing costs — These are the various fees that add up during the mortgage process. They include fees for mortgage loan origination, home appraisal, title search, document preparation and more. Closing costs can easily add up to thousands of dollars. There are two general categories: (A) fees charged by the lender, and (B) fees charged by third parties such as home appraisers and title companies.
• No-closing-cost mortgage — As the name suggests, this is a home loan scenario where the borrower pays no costs to close the loan. This can be done in two ways. The mortgage lender can simply waive the closing costs as an enticement to borrowers (which is rare), or the lender can assign a higher interest rate in lieu of closing costs. The second scenario is more common.

Is it possible to refinance a mortgage loan with no closing costs? Yes. The real question is, does it make sense to do so? In some cases, this can be a sensible strategy that saves the borrower money. In other cases, it can be a money loser. Time makes all the difference.

Related: When should I refinance my home?

No-Closing-Cost Mortgage Refinance Is a Trade-Off

No-closing-cost refinance loans typically come with a higher interest rate. So the lender is basically offering you a trade-off. They will pay your closing costs, while assigning a higher interest rates on the new loan. You can reduce or completely eliminate your upfront mortgage costs, but you'll pay a higher interest rate for that privilege.

As a borrower, you must do the math to determine how this will pay off in the long run. You want to compare the amount you save (by not paying closing costs) to the higher amount of interest paid every month. Using these two figures, you can determine your break-even point.

Here's how Cameron Findlay, chief economist for LendingTree, explained it on Bankrate.com:

"You have to look at the break-even," Findlay said. "Say, for example, you had a loan for a while at 6.5 percent and are only looking at being in the house for another four years. Then, you are probably a good candidate [for a no-closing-cost refinance loan]. You don't want to put money down if you are going to be there for four years."

In the four-year scenario mentioned above, it might be wise to skip the closing costs and take the higher interest rate. This is because you wouldn't be paying the higher interest rate for very long. So the money saved at closing would likely exceed the extra interest paid during the four-year period.

Over a longer period of time, however, this strategy begins to make less sense. According to Joe Parsons, a loan officer at PFS Funding:

"While buyers may not pay any extra immediately, they could end up paying a lot more in interest over the life of the mortgage since the lender is going to raise the interest rate to cover the [waived] costs."

With a no-closing-cost mortgage refinance, you're basically choosing between an upfront out-of-pocket expense, and a slightly higher monthly expense. Will it work to your advantage? That depends on the timing, more than anything. Let's look at an example...

Example of Potential Savings and Benefit

This will all make more sense if we plug in some numbers. Here's an example of how a borrower could come out ahead using a no-closing-cost refinance loan, even if the lender increases the interest rate charged on the new loan.

• (A) Interest rate on existing mortgage loan = 7.50%
• (B) Rate offered on refinance loan with closing costs = 4.25%
• (C) Rate offered on refinance loan with no closing costs = 4.70%

In this scenario, the lender has increased the interest rate assigned to the new loan (item 'C') because the borrower chose to forgo closing costs. But the borrower is still getting a much lower rate than the one assigned to the current mortgage (item 'A'). So two goals have been achieved here -- the homeowner has refinanced into a lower interest rate, while avoiding closing costs at the same time.

Recap: Some mortgage lenders offer no-closing-cost refinancing as a way to attract borrowers. In exchange for covering the borrower's closing costs, the lender will usually charge a higher interest rate on the new loan (compared to the rate they might have offered with closing costs). Borrowers must consider the length of time they will keep the new loan, and how the additional interest will accumulate during that time. If the rate assigned to the new loan is significantly lower than the original rate on the loan being refinanced, the borrower could experience the "best of both worlds," long-term savings without upfront closing costs.

Disclaimer: This article provides a general overview of no-closing-cost mortgage refinance. It explains the basic pros and cons borrowers must consider when pursuing this strategy. Despite the length of this tutorial, there is more to learn about this subject. Refinancing can be a highly complex mortgage strategy. Thus, we encourage you to conduct additional research beyond this website.