You can refinance your home with no closing costs — but there's a major downside

Mortgage refinancing is a common option if you’re looking to lower your monthly payment or save money on interest. However, there is also a sum of upfront expenses you’ll have to cover first in the form of new closing costs.

Some mortgage lenders offer what’s called a no closing cost mortgage. If you’re thinking "what’s the catch?" along with whether this would be a wise option for you, here’s what you need to know about no closing cost refinance options.

What is a no-closing cost refinance?

Just as it sounds, a no-closing cost refinance means you won’t have to pay upfront for fees like your application, the loan origination, a re-appraisal of your home and a new home inspection. Instead, these costs will get moved to your principal loan amount so you can pay them off with your mortgage.

Lenders may also offer you no closing costs to refinance your mortgage but give you a higher interest rate as a result. This means you may end up paying for your closing costs in the form of loan interest over time. While a higher interest rate doesn’t change your principal amount on your mortgage, it can still increase your monthly payment, which is the opposite of what most homeowners looking to refinance want to do.

WHY IT'S A GOOD IDEA TO REFINANCE YOUR MORTGAGE WHILE RATES ARE LOW

Major drawback of no-closing cost refinance

Aside from potentially higher monthly payments, the major drawback is you probably won’t get the best loan terms even if your credit score is great. You could get stuck with a higher interest rate and you will have a higher principal loan balance.

There are also some costs and fees

The average closing costs for a mortgage refi is around $5,000, according to Freddie Mac, but homeowners can expect to spend anywhere from 2% to 5% of their loan amount. For example, if you owe $225,000 on your mortgage and choose to refinance, your closing costs could be anywhere from $4,500 to $11,250.

Let’s look at how this might add up with a no closing cost mortgage. If you refinance your home with a principal of $225,000 and closing costs are $7,000, this amount would just get added to your loan for a new principal total of $232,000.

Let’s say you go with a no closing cost refinance where your lender will:

• Add the $7,000 closing cost total to your principal loan balance
• Increase your interest rate to 4.5%

This could leave you paying $87,461 in interest over the 15-year term instead. Visit Credible to get prequalified rates without impacting your credit score.

WHO'S EXEMPT FROM THE NEW MORTGAGE REFINANCE FEE?

Is a no closing cost mortgage refinance right for you?

A no closing cost refinance could be the right move if you are tight on liquid cash but want to refinance your home quickly. If you don’t plan to stay in your home for more than five years, you could move and sell it before incurring those long-term costs.

The key benefit is you won’t have to pay closing costs on your new mortgage loan upfront. While you will still pay extra costs down the line, you don’t have to worry about gathering the liquid funds to do so in order to secure your refinance.

REFINANCE YOUR MORTGAGE BEFORE RECORD LOW RATES DISAPPEAR

Other mortgage refinance options

If you’re leaning away from a no closing cost mortgage refinance, here are some other options.

• Conventional Refinance: Have another type of mortgage but are looking to refinance to a conventional mortgage? Doing so is easy if you have good credit, equity in your home and can cover closing costs. Refinancing from a 30-year to a 15-year mortgage can also save you a ton of money.
• Cash-Out Refinance: Refinance your new mortgage and borrow money at the same time with this option. A cash-out refinance allows you to also roll your closing costs into the amount of the loan and also receive a check. So, your new loan amount will likely be higher due to the number of closing costs and the cash you receive.
• FHA Streamline: An FHA streamline refinance requires less paperwork (often no new appraisal on the home is needed) so you’ll save money on closing costs and can obtain a new home loan with a lower interest rate quickly.

HOW TO GET THE BEST MORTGAGE REFI RATES