What is refinancing?
Refinancing refers to replacing an existing debt obligation with another debt obligation under different terms and conditions. The most widespread consumer refinancing is for home mortgages. A loan or debt can be refinanced for a variety of reasons.
- To capitalize on better mortgage interest rates
- To merge other debts into one loan
- To lower the monthly repayment amount
- To alter or reduce the risk (for example, changing from a variable rate to a fixed rate loan)
- To free up cash
At one time or another, many homeowners will seek to refinance their existing mortgage. There are several things to keep in mind when doing this. One of the main concerns is obviously interest rate. Closing costs should also be considered. Since closing costs can be very prohibitive, many consumers are searching for a no cost or low cost mortgage. These have been designed to accommodate the growing demand for more reasonably priced loans.
Categories of Mortgage Loan Costs
All loans have costs connected to them and these costs usually fall within three categories:
Mortgage points refer to prepaid interest on a loan. They are also called origination or discount fees. The origination fees go to the broker or lender who processes the loan, while discount fees are paid to the lender who funds the loan. For example, one point is equivalent to one percent of the loan amount. Therefore, for a $200,000 mortgage, one point is $2,000 and two points, $4,000.
Non-recurring Closing Costs (NRCCs)
These include credit, appraisal, escrow, title, recording fees, notary, lender ‘garbage fees’ which may include underwriting fees, document preparation fees, processing fees, administration fees, among others. These are fees that are directly associated with getting the loan and are fees you would not be paying for outside the loan process. When points are not included in this figure, the total could be referred to the borrower’s base closing costs.
Recurring Closing Costs
These are your current property taxes, insurance and mortgage interest. These are you would have to pay even if you were not applying for a new loan. Though they are not true costs of getting a loan, you may be required to pay them at closing because of the loan closure’s timing. It is recommended that these costs are paid out of pocket since to do otherwise might mean financing any property taxes, homeowners’ insurance and pro-rated interest for many years, at a great interest expense to you.
What is a No Cost Refinance?
No cost refinances are also referred to as no-cost mortgage refinances or no fee refinances. A no cost refinance is basically a loan transaction where the broker or lender pays settlement costs, including usual fees such as underwriting and processing fees, escrow/title fees, appraisal fees, loan origination points, among others. A lender or bank may also merge your closing costs with your loan amount, thus increasing the size of your loan and making it a ‘no cash’ loan. Although you might avoid upfront fees and out of pocket expenses, these costs are not paid by the lender, and thus the loan is not a real no-cost loan.
Low cost or no cost mortgages usually have a higher interest than the conventional loan. The higher rates compensate the lender for fees which they have paid for you. For example, for a $250,000 mortgage, the closing costs may equal $6,000. For an ordinary mortgage, the buyer will be required to pay the closing costs from their own pocket, and the mortgage’s interest rate will be 6.5 percent. With a no cost mortgage, buyers will not be required to pay any closing costs from their own pocket. However, the interest rate will be 7 percent. This means higher monthly payments.
Even when you don’t have cash up front, many lenders will finance the closing costs of your loan for you. This is fine when you have equity in your home for it. Something else to consider is the prepayment penalty. If you plan to stay in your home for some time, this should not be a problem. But if you are considering moving in a few years, make sure you know the fee required for early payment of the loan.
When is no cost refinance a good idea?
If you plan to stay in your home for just a few years, a no cost refinancing loan could be the ideal way to save some money. Instead of paying a lot of money upfront, a no cost option may mean immediate ownership at a reduced price. You will need to compare payments on a conventional refinance with those of a no cost refinance. Eventually, the higher cost of the no cost refinance will add up and exceed what you might have paid in upfront closing costs. Basically, if you pay off the loan before reaching the break even point, the no cost mortgage saves you money. Otherwise, it costs you more. To make a more precise evaluation, think about the added tax benefits from the higher interest rate, plus how your savings may be affected if you pay the closing costs upfront.
If you want to refinance your home to cut costs, no cost refinancing is appropriate. Homeowners can capitalize on lower interest rates in the market without exorbitant closing costs. If interest rates continue to reduce over the years, a homeowner can simply refinance again to get extra savings, and avoid closing costs with this kind of mortgage.
If you are planning to stay in your home for a long period of time, no cost refinancing may not be appropriate. A reduced rate offered by normal mortgages will be beneficial over a long period, and closing costs will be recovered by the savings over this time.
You need to remember that lenders are different and each has particular requirements for each loan. Depending on the type of mortgage, you might discover that your no closing cost mortgage might actually involve some fees. Some programs might cover all the costs, whereas others might charge you for specific third-party fees such as insurance, taxes, diem interest, and even points.
Low cost and no cost mortgage refinance are very common nowadays. When searching for a reasonably priced mortgage, compare all the alternatives and calculate how much you could save in the long run. Be sure to read all the conditions and negotiate for the most favorable deal. If you do your homework well, a no cost mortgage may be the right option for you.