What is a no closing cost refinance?

If you want to refinance your home loan to secure better terms or access some of your equity, you can do so, even if you don’t have cash on hand for the closing costs. Typically, mortgage refinance closing costs can range between 2% and 5% of your loan amount and cover expenses such as the application fee and home appraisal. Your closing costs vary by the lender, the type of loan and where you live.

A no-closing-cost refinance rolls all of your closing costs into your new loan so that you don’t have to worry about paying the fees upfront. While this might be a good option for many homeowners, there are a few things to consider before choosing to refinance with no closing costs.

Key insights:

• No-closing-cost refinances still have extra costs and fees.
• Lenders can charge a higher interest rate or add your closing costs to your loan total.
• You will pay more for your home loan with a no-closing-cost refinance.

What are closing costs for refinancing?

Closing costs are the additional fees you must pay for a new home purchase or refinance loan. Because refinancing involves taking out a new home loan, closing costs apply no matter how long you have lived in your home. Typical closing costs include:

• Loan origination fee: This fee is set by your lender at 0.50% to 1% of your purchase price.
• Application fee: The loan application fee can be as high as $500 and varies by lender.
• Home appraisal fee: An appraiser is hired to check your property and document any notable improvements you have made to the property. The cost for an appraisal ranges from $300 to $600.
• Inspection fee: A home inspection fee costs $300 to $500. While you might have had the option to skip the inspection when you initially purchased the home, your lender will require it now before approving the refinance.
• Survey fee: A surveyor identifies property boundaries and lets buyers know what they can and cannot do on their property. The cost of a surveyor is $65 to $85.
• Credit report fee: A credit report fee costs $30 or less, and it is the only fee a lender can ask for before a loan estimate.
• Title and title insurance fees: You will need new lender’s title insurance since a refinance is a new loan on your existing home. Title insurance is 0.50% to 1% of the purchase amount.

Some of these closing costs, such as the origination fee and application, are negotiable with the lender or seller. Other fees, such as the appraisal fee, are not.

How a no-closing-cost refinance works

While a no-closing-cost refinance sounds like a free ride from the lender, it isn’t. There are always closing costs when you purchase a home, refinance a home or even choose a home equity line of credit (HELOC). The term “no closing costs” means you don’t have to pay for closing costs upfront.

There are two types of no-closing-cost refinances. The first is when a lender pays for your closing costs, such as your origination fees and appraisal fees. In exchange, your loan interest rate will be slightly higher. While this may not seem like much, note that even a 0.50% higher interest rate can cost you thousands extra in interest costs over the life of your loan.

The second option is when the lender rolls the total amount of closing costs into the home loan. For example, if you are refinancing $400,000 and have $12,000 in closing costs, your new loan is now $412,000. This new total means you now have less equity in your home. However, the upside is that you keep more cash on hand, and adding the closing costs to your property total could ultimately be cheaper than paying a higher percentage rate.

Pros of no-closing-cost refinance

No-closing-cost refinances can be done for traditional rate-and-term refinances or cash-out refinances. Here are a few benefits of choosing this refinance option:

• You don’t need to come up with money upfront. Not everyone can afford the high closing costs that come with a refinance. If you are looking to do a cash-out refinance, you probably want to maximize your cash on hand. With a no-closing-cost refinance, you don’t have to worry about covering the extra fees before the loan goes through.
• You can simplify the mortgage shopping experience. Comparing lenders is a good idea, but it can also be overwhelming. Narrowing your search to just lenders that offer no-closing-cost refinances can simplify the process.
• You don’t have to touch your emergency fund. Draining your emergency fund to pay for refinancing costs is not financially wise. You need a devoted emergency fund in case of things like a medical accident or unplanned loss of income.

Cons of no-closing-cost refinance

When a lender advertises a no-closing-cost refinance, it does not mean it is a free loan.

"The cost is built into the interest rate and you take a higher-than-market interest rate to offset the cost,” said California-based real estate agent Joshua Sinatra. “Typically these loans are done at 0.25% to 0.50% higher than the market rate."

Before you choose to refinance without closing costs, here are a few other things to consider:

• Your monthly mortgage payment will be higher. Whether your interest rate is higher — even with excellent credit — or your loan principal is greater, your monthly payment is higher than if you pay closing costs upfront.
• You will pay more over the life of the loan. Along with paying more monthly, you will be paying more over the life of the loan. Adding $9,000 to $15,000 in closing costs to your new loan adds up when you are repaying it with interest over a 15- or 30-year term.
• A prepayment penalty might be applied to your loan. Lenders that want to benefit from rolling your closing costs into your loan might also put a prepayment penalty in your loan terms. Some lenders might also restrict you from refinancing your loan for the first few years.

Bottom line

A no-closing-cost refinance has a somewhat misleading name, given that borrowers end up paying extra costs in the form of a higher principal balance or interest rate. However, for those who need to refinance but do not have the extra cash to do so upfront, a no-closing-cost refinance is an option. Homeowners should still compare lenders and look for the loan that has the lowest total cost of borrowing.