No Closing Cost Refinance

No closing cost refinance offers allow homeowners short of cash take advantage of today’s low mortgage rates. Sounds good, but if lenders offer no closing cost refinance loans then why isn’t everyone refinancing this way? There is of course a catch which could wind up costing you thousands of dollars unnecessarily. Here are the pros and cons of no closing cost refinance offers to help you make an informed decision for your next home loan.

How Does No Closing Cost Refinance Work?

There’s no free lunches for pretty much everything these days and this is doubly so when it comes to mortgage refinancing. No closing cost refinance loans still have closing costs, every mortgage has fees regardless of what you’re doing; however, in this case the lender is paying your underwriting and loan origination fees for you.

Why would a lender pay your mortgage fees for you? They do this because you’re accepting higher than market refinance rates, meaning your payments will be higher than necessary for the entire duration of your home loan. This markup of your interest rate is called Yield Spread Premium. The cash lenders pay can be used to pay your broker’s fee or in the case of no closing cost refinance offers all of your fees.

Yield Spread Premium is Alive & Kicking

Many homeowners incorrectly think the use of Yield Spread Premium was outlawed in the United States. This is simply not the case. The only thing that changed was that if your mortgage broker accepts lender paid compensation in the form of Yield Spread Premium they cannot also charge you the loan origination fee. This “double-dipping” is partially what earned mortgage brokers a reputation for being money-grubbing used car salesmen.

How does Yield Spread Premium work? It’s a pretty simple concept to wrap your head around. For every .25 percent you agree to pay above par refinance rates the lender pays one percent of your home loan towards the origination fee and closing costs. Since your monthly payment is based on your mortgage rate and term length any amount of Yield Spread Premium on your loan is going to result in higher payments.

Is No Fee Mortgage Refinancing Worthwhile?

For some people who simply don’t have the cash to take advantage of today’s low refinance rates it can be worthwhile, especially if you’re paying six percent or higher on your existing mortgage. Here’s an example to illustrate what the markup does to your payment on a typical mortgage refinancing transaction.

Suppose you’re going to refinance your home for $300,000. Your current home loan has an interest rate of 6 percent and a monthly payment of $1,798. Considering 30 year fixed refinance rates are currently right around four percent mortgage refinancing makes sense for any homeowner in this situation. In this example we’ll use $6,000 as estimated closing costs including the origination fee, appraisal, attorney fees and underwriting fees. In order to cover $6,000 in mortgage fees you’d have to accept half a point in Yield Spread Premium to get your fees paid. In this case refinance rates of 4.5 percent would get the job done; however, what does this markup do to your payments?

If you paid your own closing costs and closed with refinance rates of 4 percent your monthly payment would be $1,432. The no closing cost refinance at 4.5 percent gets you a payment of $1,520 per month. That’s a difference of $88 per month or $1,056 per year. After five years you’ll have paid $5,280 for $6,000 in closing costs. Considering that the average homeowner refinance every 4-5 years in this example the no closing cost refinance offer makes sense if you ditch the mortgage after five years. Keep this home loan for any longer than five years and you’ll start losing money.

Should you take one of these no closing cost refinance offers? On paper they can seem like a good deal when you run the numbers, especially if not having cash would prevent you from lowering your payments with today’s ridiculously low refinance rates. Just make sure that your loan contract doesn’t include a prepayment penalty as this would make getting out of the loan a losing proposition down the road when you’re ready to sell or refinance again.