How a No Cost Refinance Works

By Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Edited by Michael Jensen, Mortgage and Finance Guru

Updated November 6, 2020

Borrowers are often bombarded with marketing messages for no cost refinance programs that promise you the ability to refinance your mortgage without paying any costs.  This seems like a great deal for borrowers -- you can refinance your loan and potentially lower your mortgage rate for free, or at least with no out of pocket expenses.  Lenders are supposed to pay all closing costs including origination, underwriting, appraisal report, title and escrow fees.  Closing costs typically run in the thousands of dollars so no cost refinance programs are especially appealing to borrowers who may be short on funds but still want to realize the benefits of refinancing their mortgage.

Although a no cost refinance sounds like an attractive option for many borrowers, there are several points to keep in mind. A no cost refinance may actually include certain fees or expenses, plus even if you are not required to pay any closing costs, you may end up paying more in the long run with a higher mortgage rate.  Below we outline the key points to think about if you are considering a no cost refinance.

If you are interested in a no cost mortgage be sure to ask the lender upfront what costs you are required to pay, if any.  For a true no cost refinance, borrowers are not required to pay any lender or third party fees or expenses.  In some cases lenders request that borrowers pay for non-lender closing costs such as appraisal, title and settlement agent or escrow fees.  This is not a real no cost refinance because the borrower is required to pay certain transaction expenses.

• Review How Much Are Mortgage Closing Costs?

Additionally, make sure that no costs are rolled into your new mortgage, which increases your loan amount and monthly payment. Adding closing costs to your loan amount is a clever way for lenders to make borrowers pay costs without charging you upfront fees. With a legitimate no cost refinance your loan amount at closing should equal the loan amount you agreed to at the beginning of the process.

In other cases, a no cost refinance may require the borrower to pay certain costs upfront, such as the appraisal report fee, and then these costs are rebated to the borrower when the mortgage closes. This is considered a no cost refinance because the borrower recovers the upfront expenses when the loan funds.

The best way to check if a refinancing is truly no cost is to compare the mortgage rate to the Annual Percentage Rate (APR) found on page three of the Loan Estimate. The Loan Estimate outlines the key mortgage terms and features including the APR. The lender is required to provide a Loan Estimate to the borrower within three days of the borrower submitting a loan application. In short, the APR represents what your mortgage rate would be if it included all upfront lender and closing costs. If a refinancing is truly no cost then the APR should equal the mortgage rate. If the APR is higher than the mortgage rate then you know the refinancing is not really no cost and you will be required to pay certain closing fees.

The table below shows refinance mortgage rates, fees and APRs for leading lenders in your area.  You can compare the interest rates and APR to understand if you are required to pay closing costs.  For a true no cost refinance, the APR is the same as the interest rate.  We recommend that you contact multiple lenders in the table below and request refinance terms.  Comparing lenders and proposals is the best way to save money when you refinance.

The important point to understand about how a no cost refinance works is that you usually pay a higher mortgage rate as compared to a loan with standard closing costs.  For example, a lender may quote you a 4.250% mortgage rate with $2,500 in closing costs as compared to a 4.500% rate with no closing costs.  In some cases the lender charges you a higher rate but provides a lender rebate when your mortgage closes to pay for all or part of your closing costs.

• Use ourMORTGAGE COMPARISON CALCULATOR to compare loans with different mortgage rates and closing costs

Paying little or no closing costs sounds good, especially if you do not have a lot of money saved for closing fees, but paying a higher interest rate means that your monthly payment is higher plus you usually pay thousands more in interest expense over the life of the loan. So even though you do not pay any upfront costs to refinance your loan, you may end up paying a significantly more in total interest expense as compared to the closing costs you would have paid with a standard refinance.

For example, you may save $2,500 upfront by not paying closing costs but you may pay thousands more in interest over the course of your mortgage and your monthly payment is higher. As illustrated by the example below, borrowers need to understand the trade-off between paying less costs upfront but potentially much more interest expense in the long run.  Paying more over the course of your mortgage may make sense for borrowers who can significantly lower their interest rate by refinancing or for borrowers who could not otherwise afford to refinance, but it is important to understand the additional total costs involved.

The example below compares a no cost refinance to a refinance with typical closing costs.  The no cost refinancing charges a higher mortgage rate -- 4.250% as compared to 4.000% for the refinance with standard costs -- which results in a higher monthly mortgage payment and significantly more interest expense.

In this example the borrower ends up paying over $12,000 more over the life of the mortgage by choosing a no cost refinance.  This is because although the borrower saves $3,500 by not paying closing costs upfront, he or she pays a higher mortgage rate for the entire loan.  Paying a higher rate adds up over time and costs the borrower almost $16,000 more in total interest expense.

Before you move forward with a no cost refinance it is important to compare mortgage rates, closing costs and total interest expense for multiple refinance quotes. Borrowers should understand their full range of options to find the refinance program and lender that best meet their budget and financial goals in both the short and long term.

Use our personalized mortgage quote feature to compare no obligation refinance quotes. Our quote feature is free, easy-to-use, requires minimal personal information and does not impact your credit. Comparing multiple refinance quotes enables you to find the best mortgage terms including the lowest rate and fees.

Sources

"Determining Costs."  My Home by Freddie Mac.  Freddie Mac, 2019.  Web.

“Is there such a thing as a no-cost or no-closing loan or refinancing?”  CFPB.  Consumer Financial Protection Bureau, February 24 2017.  Web.