By manybanking.com Staff
Refinancing your mortgage without having to pay the closing costs? Sounds like the best deal in town, with the savings from a lower interest rate kicking in right away since there are no upfront costs. But a "no-cost" refinancing can actually end up costing you more in the long run. Here's how to figure out whether it's right for you.
With no-cost refinancing, your lender pays the one-time closing costs, which include such things as title insurance, an appraisal fee, and attorney fees. (You'd still have to pay any private mortgage insurance, pre-paid interest and property taxes.) In exchange, your lender boosts the interest rate on your loan -- often by 0.25 percentage points or more. As with a normal refinance, there is a break-even point based on how long you expect to stay in your home. But in this case, if you plan to stay in your home beyond the break-even point, you're better off choosing a lower rate and paying the upfront closing costs.
Consider this example: Say you have $200,000 remaining on your existing mortgage, and you want to take advantage of the recent drop in interest rates. Your lender offers you a choice between Mortgage A, a $200,000, 30-year fixed-rate mortgage (FRM) with an interest rate of 5.25% and $2,500 in closing costs; and Mortgage B, a $200,000 30-year FRM with a rate of 5.5% and no closing costs. (To help crunch the numbers, turn to manybanking.com's Mortgage Loan calculator.)
Mortgages A and B have monthly payments of $1,104 and $1,136, respectively -- a difference of $32. It will take just over six and a half years before paying $32 more per month exceeds the $2,500 you saved by not paying the closing costs. If you sell your home (or refinance) before the break-even point, "no-cost" refinancing was the right decision. If you end up keeping your loan beyond the six and a half years, the lower interest rate on Mortgage B makes more sense.
However, if your lender raises your interest rate by more than 0.25 percentage points, or the closing costs are less than $2,500, your break-even point will come more quickly. Revisit the numbers based on the information your lender provides you, to see which option makes sense in your situation. And be sure to shop around to get the best rate. Enter your ZIP code at manybanking.com's mortgage section to get rate offers in your area.
For more on the topic, read these tips on when it makes sense to refinance.
And here are some ideas towards keeping your closing costs down.