subject: When Does a No Closing Cost Refinance Make Sense? [print this page] When Does a No Closing Cost Refinance Make Sense?
Unless you have been living on a deserted island for the past few years, you likely have been solicited for refinancing. Turn on the radio for a few hours and someone will surely try to pitch you on a no closing cost refinance. Truth-be-told, there are expenses with every mortgage transaction. During the process, an originator takes your application, which then gets handed to a processor who organizes the documentation, which then gets passed to an underwriter who reviews the files, who then passed it back to the originator or processor to collect any outstanding collateral, who then passes it back to the underwriter, who finally hands the file to the closer to send the documents to the attorney and/or title agent for signing. And that's just what the mortgage company does. The attorney, appraiser, and title company are also working behind the scenes on your mortgage. How can all of these people work on a loan at no expense to the borrower? It's pretty simple, they can't. What happens is that the mortgage company offers a higher rate where they make more money and then turns around and pays for their expenses, and third party expenses, with the extra money they are making on the loan. Still sound like a sweet deal? Actually, it can be.
It comes down to math. For example, let's say a borrower can get a $250,000 30 year fixed rate mortgage at 5.000% with $3,000 in closing costs. Or, they can get a $250,000 loan at 5.500% with no closing costs. The monthly principal and interest payment at 5.000% would be $1,342.05 while the payment would be $1,419.47 at 5.500%. That is a difference of $77.42 per month. So, it would take almost 39 months for a borrower to save about $3,000 with the lower rate/higher fee closing cost option. If he or she was planning on being in their home for more than five years and did not think that they were going to refinance again, they may want to opt to pay the fees as they would save $77.42 for the other 321 months of the mortgage. That's almost $25,000.
Paying mortgage points requires that the consumer do the same type of cost-benefits analysis. If you are offered a $250,000 30 year fixed rate mortgage with a note rate of 4.75% with 1 points ($250,000 X 1% = $2,500) and $3,000 in closing costs, you need to add the cost of the point ($2,500) with the closing costs ($3,000). The principal and interest payment would be $1,304.12. That is a $37.93 monthly savings when compared with a 5.000% note rate with $3,000 in closing costs. It would take almost 66 months in order to start savings money by paying the point. As with the previous example, it may make sense if you are planning on being in the home (and the mortgage) well beyond the fifth year as you will continue to pay $37.93 less every month thereafter.
Today, a large percentage of consumers either refinance or switch homes every 5 to 7 years. Unless you are planning on being in a home for an extended amount of time, a no closing cost refinance might be the right choice. Plus, the $3,000 you would have to pay towards the closing costs could be used towards other investments thus creating the ability to turn that amount into even more money. A licensed and qualified mortgage professional can help you sort through your options so that you can make a well informed financial decision for you and your family.
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