We sometimes get asked if there are really no cost refinances out there or if that is simply marketing spin by banks. The short answer is yes, no cost refinances do exist, but they are more rare than many lenders imply with their advertising.
As the old saying goes, there is no such thing as a free lunch. In this case there is technically no such thing as a truly “no cost” refinance because either the lender has to pay for the costs of a refinance or you do. However there are cases when lenders are willing to pay for all of your closing costs on refinances so it can be no cost to you. Lenders are able to do this because on most loans they are being paid a commission or finders fee for the mortgage by their investors. So for example, if an investor is willing to pay a lender $3000 for servicing rights to your new government-backed mortgage the lender can pay $2000 of your closing costs and still not lose money on the transaction.
Most likely no-cost mortgages
– FHA streamlines for FHA loans that were closed more than three years ago. If you have an FHA loan that you got in the spring of 2009 or earlier you could qualify a real no-cost FHA streamline refinance. For people in this situation the FHA has waived virtually all of the upfront mortgage insurance fees and does not allow any other closing costs to be rolled into the new loan. This results in a refinance that really does significantly reduce interest payments and payments without costing borrowers anything. Contact us to learn more about this program if you currently have an FHA loan.
– Most other types of refinances with slightly higher interest rates. For other types of refinances the most likely way to get a no cost refinance is to get a rate that is a quarter point or more higher than than average. For instance if the average mortgage rate is 3.75% you can normally get most or all of your closing costs paid for by the lender by going with a 4.0% rate. The higher interest rate gives lenders more money to pay for costs, including both the up front out of pocket expense and the costs rolled into the loan. It doesn’t always make sense to go for higher interest rates and lower closing costs though because the longer you own the property the more valuable the lower interest rate becomes.
Out of pocket costs vs. costs rolled into the loan.
Sometimes lenders will tell you that if you bring no cash to closing that it is a “no cost” refinance. But if closing costs are rolled into your new mortgage there are still costs to you. If $5000 in closing costs get rolled into your new mortgage that means you are $5000 deeper in debt and you still have to pay that money back eventually. It is important to calculate the actual costs and the number of months it takes to break even on those costs before proceeding with a refinance. (*Contact us to be connected with authorized lenders who always help borrowers calculate break even costs.*) Normally if you plan to own the house 5+ years you should be alright with a break even point of less than 2 years on a refinance but the faster you can break even the better.
Fill in the contact form on the right to get more information on this topic or to find out which government-backed refinance programs you can qualify for. With rates at all time lows this month there may never be a better time to refinance your mortgage.