Recently we refinanced our home into a 15 year fixed mortgage. We did so via a no closing cost refinance, a tool which has its place in some situations.
Cost to Refinance
A typical refinance of a $200K home can cost between $2000-$3000. In order to make out ahead on a home refinance you need to recover this in reduced interest over time. So, if you have a $150K mortgage, it will take somewhere between 2 and 3 years to pay back the interest. The problem is what happens if you’re unsure about the near term future. This could mean that I’m aggressively paying off my loan as a stretch goal and if successful will pay off in the next 2-5 years. It could also mean I may need to move in the next 5 years for some reason. The crucial piece of this situation is being unsure, that means recouping your closing costs is not a foregone conclusion. If you know that you will be there for longer then 5 years, get a longer term loan. However, if you’re not sure on these questions, you can lower your rate over the same or shorter term using no cost refinance loans which as the name implies, leave you with no costs to recoup.
You Still Pay
The most important thing to realize is TANSTAAFL: there ain’t no such thing as a free lunch. Regardless of your choices the lender ultimately will get paid for the loan. However, there are more ways than one for the lender to get paid. In fact there are 2:
The first is where the lender puts the cost of the refinance into your loan principle. This approach is not gaining you anything from a total dollar perspective over paying the refinance cost. It still might be better to do so then not refinance if you’re not in one of the scenarios I mentioned where the loan could be paid off in a few short years for a move or pay ahead. However, I would personally not consider it unless I had a cash shortage, and then I likely wouldn’t be approved for the mortgage due to lack of cash reserves.
The second approach is for the lender to raise the interest rate and give you a credit for the higher rate, similar to mortgage points in reverse. This is the method you should be using with a potential short timeline.
Our Experience Using a No Closing Cost Refinance
In our case, we had been sitting on the sidelines trying to decide on a refinance for some time due to both job volatility and early prepayment possibilities. Ultimately, we refinanced to a 15 year fixed loan from a 30 year fixed loan. Thankfully we were paid ahead enough that the monthly bill was equal after the refinance. We went from 4.125% to 3.125%. The total out of pocket, not counting escrow and prepaid interest that we would have paid within our loan anyway was $0 dollars. In exchange for the time hassle of dealing with the assessment, lawyers, and mortgage company we’ve saved 1% a year until the point we decide to bail or pay off. In our case, I estimate we will bank an extra 6K over the next 5 years if we do nothing.
We used an online lender to do our refinance, Elend, as they had a much cheaper rate then the major banks and were willing to do a no closing cost loan. As anyone will tell you, refinancing is a stressful activity post 2009, but if you stick to it the pay back will be worth it.
Have you refinanced recently?