Understanding No-Closing-Cost Refinance: A Comprehensive Guide for Borrowers

For qualified borrowers, some lenders offer no-closing-cost refinance or zero-closing-cost refinance loans. These mortgage loans allow you to roll closing costs into the loan, making the initial closing costs seem non-existent. It’s important to understand that while the upfront cost is eliminated, the loan will still be more expensive over time due to the added interest.

No-Cost Refinance: The Basics

No-cost refinance is a popular option that seems like a win for many borrowers. Instead of paying thousands in closing costs upfront, these costs are simply shifted into the loan. The fees for services such as appraisal, processing, and underwriting are waived by the mortgage company, making the initial closing costs disappear. However, this convenience comes at a cost.

Understanding the True Costs

It’s crucial to recognize that no closing cost refinance is a misnomer. In reality, every real estate transaction involves closing costs. These costs can be split into two main categories:

Non-Recurring Closing Costs

Title and escrow fees Appraisal fees Notary fees County recording fees

In some cases, a property inspection waiver may be granted, allowing the borrower to not incur appraisal fees. However, this decision is made by the automated underwriting system used by lenders, not individually by the lender.

Prorations and Prepaids

Prorated interest: If you complete your refinance on the 15th of April, you’ll pay 15 days' interest on the old loan and 15 days' interest on the new one. This is because mortgage interest is in arrears. The interest for May will be paid in June. The lender will collect prepaid interest for 15 days covering the period from April 15 to April 30. Impound funding (escrow account): This covers payments for property taxes and home insurance. The amount they collect depends on the state's tax calendar and the renewal date of the homeowner's insurance policy. In California, for example, the initial payment could be as few as two months' tax payments and as many as nine months. Property tax installment: If a current installment of taxes will be due before the borrower’s first payment, the lender will require payment of that installment at closing. Rebate from the lender: If the borrower selects a higher interest rate, they may receive a rebate from the lender. For instance, if the “par” rate today is 4%, and the borrower raises it to 4.5%, they may receive a rebate of 2.5% of the loan amount.

Important Considerations

While no-cost refinance offers an attractive initial look, there are several important factors to consider:

Higher monthly payments: Rolling closing costs into the loan means higher monthly payments over the life of the loan. Long-term implications: If the borrower plans to stay in the home for more than two or three years, the higher interest rate could make the loan more expensive overall. Equity and costs: Borrowers should be aware that they are paying the costs using their home’s equity, not in cash. This means they are not getting a cost-free loan.

The Current Market Landscape

As of April 1, 2020, the mortgage market is in turmoil due to the COVID-19 pandemic. The rate-and-point relationship may not reflect the typical relationship. Despite this, we expect a return to normalcy within two to three months. Consumers should understand that some loan officers may tell them that their loan has no costs, but what they mean is that the borrower will not have to pay any money out of pocket because the costs are included in the new loan.

Conclusion

Understanding no-closing-cost refinance is crucial for borrowers. While it appears to offer a way to avoid upfront costs, the true costs are simply shifted into the loan. Borrowers must consider the long-term implications and weigh the benefits against the additional monthly payments.