No Cost Refinance Loans

If you’re shopping for mortgage refinancing with today’s best mortgage lenders you’re likely to run across advertisements for “no cost refi” loans. These lenders promise to refinance your home without fees or out-of-pocket expenses. Skeptical? You should be. If lenders are willing to refinance with no cost why isn’t everyone doing this? As with anything, if something seems too good to true there’s always a catch and the catch with no cost refinance loans is expensive.

No Cost Refinance Offers

Zero or no cost refinance loans are transactions where the lender pays your broker fee and closing costs. Typical closing costs include loan processing, underwriting and the origination fee, appraisal, title, escrow and any discount points you agree to pay.

Another option is not “no cost” refinancing but bundles your closing costs with your loan balance, increasing the amount you owe. Bundling closing costs when refinancing is a common practice with many lenders making it a “zero cash” transaction.

In this case you’re paying your settlement charges including interest for the entire duration of your loan. The compounding effect of financing your closing costs tends to make this a bad deal.

How Zero Cost Refinancing Works

Every home loan has fees that must be paid at closing. Mortgage lenders don’t waive their fees and your broker is going to get paid, so how do these loans work?

Assuming you have a no fee refinance and not one where your fees are rolled into the loan balance, you’ll find mortgage refinance rates are substantially higher than if you had paid the closing costs yourself. This markup of your mortgage rate is known as Yield Spread Premium and the cash created is used to pay the broker fee and closing costs.

How does Yield Spread Premium work? Lenders pay a fee for home loans that close with higher than par interest rates. Par mortgage rates are simply the lowest interest rate that doesn’t require discount points or includes Yield Spread Premium markup.

Many homeowners mistakenly think Yield Spread Premium was outlawed; however, changes in the law only prohibit brokers from charging you a loan origination fee AND accepting lender paid compensation for the broker fee on the same transaction.

No cost refinance offers vary from one lender to the next. Some will cover all of your closing costs while other refinance offers only cover the broker fee. You may still be required to pay discount points to qualify for a certain mortgage rate; however, many lenders will roll points into your loan balance.

Here’s an example to illustrate how no cost refinancing typically works:

• No Cost Refinance Option: 5.5 percent, zero fees
• Conventional Refinance: 5.0 Percent, $6,500 closing costs

On a 450,000 home loan that extra .5 percent can have a significant impact on your payment amount. Paying $6,500 at closing might seem like a large out-of-pocket expense, the difference in your finance costs over the lifetime of your mortgage is dramatic.

When Are No Fee Refinance Offers a Good Deal?

In this example the difference in your monthly payment is $140 per month. After five years you’ll have spent $8,400 for $6,500 in settlement charges. When does no cost mortgage refinancing make sense? If you plan on keeping your home for a short while, assuming you won’t have a prepayment penalty AND you simply don’t have the cash to pay your closing costs or broker fee, you can justify this type of offer.

No cost home loans aren’t necessarily a bad thing, the lenders that offer them aren’t necessarily evil, and these loans serve a purpose in the marketplace. Do your homework, run the numbers and you’ll avoid 90% of the common mortgage mistakes costing your neighbors thousands of dollars.