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Breaking Down No Cost Refinancing

By Staff
Mortgage refinancing has become increasingly popular with the current low interest rate environment.


One of the heavily advertised loan products is the so-called “no cost refinance.” This loan option allows homeowners to refinance with no money upfront in exchange for a slightly higher interest rate than they would otherwise pay. The interest rate difference can be between 0.25% and 0.5 %.

Typically, there are numerous non-recurring closing costs associated with a mortgage refinance. These costs include application fees, title search fees, loan origination fees, appraisal fees, inspection fees and others. These fees can add up to 3% to 6% of the loan amount in some cases. With a no-cost refinance, the lender pays for these non-recurring closing costs.

This is not, however, a gift from the lender, it’s a loan. The borrower pays the lender back in higher interest, so in effect, the lender buys the borrower negative points. The lender does not cover all closing costs in a no-cost refinance -- borrowers should be prepared to pay for property taxes, per diem interest and homeowner’s insurance at closing.

The simplest way to determine if a no-cost refinance is a good option is for the borrower to calculate the break-even period for the refinance. The break-even period is how long it will take to pay off the closing costs using the difference in the monthly payment as compared to a conventional loan on which the borrower pays the closing costs.

Consider this example: On a $200,000, 30-year refinance, the no-cost option carries an interest rate of 6%. The conventional loan carries an interest rate of 5.5% and $3,000 in closing costs. The borrower will pay $1199 a month on the no-cost version. With the conventional loan, the borrower will pay $1136, a difference of $64 per month. The break-even point would be 63 months or 5 years, 4 months ($4,000/$64).

If the borrower plans on selling the property in less than 5 years, 4 months, then the no-cost refinance makes sense because the borrower will get out of the loan before the closing costs are paid off. Otherwise, the no-cost refinance may not be a good choice. If the borrower stays after the break-even point, the monthly payment will still be an extra $64 a month, in comparison to the conventional loan. With a no-cost refinance, the lender is betting that you will stay past the break-even period.

Additionally, over the life of the loan, borrowers will pay more interest with a no-cost refinance. In the previous example, total interest on the no-cost refinance would be $231,677, and interest on the conventional loan would total $208,807. That’s a difference of $22,870 if the loan reaches maturity.

Finally, income taxes play a role in determining if a refinance loan is a good option. Closing costs on conventional loans are not tax deductible. However, with a no-cost refinance, the increase in mortgage payment is deductible. Use the Refinance Breakeven Calculator at to explore the numbers of your various refinancing options. This calculator allows borrowers to account for their income tax rate.

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