When interest rates drop, mortgage refinancing can help homeowners save money. However, closing costs could be a major roadblock to refinancing if you don’t have the cash to pay upfront. In that case, a no-closing cost refinance might seem like an appealing option.

While not paying closing costs probably sounds like a great deal, a “no cost” refinance is more complicated than that.

What Is a No-Closing-Cost Refinance?

Refinancing is the process of taking out a new mortgage and using the resulting funds to pay off your existing home loan. Usually, the goal of refinancing is to get a lower interest rate, though homeowners also refinance to change the repayment term, cash out on equity, switch the interest rate type, and so on.

A no-closing-cost refinance allows homeowners to refinance their mortgage without paying cash upfront. Whenever you refinance, you typically must pay a set of fees to cover the administrative and third-party costs of closing the loan. These costs can include the application fee, loan origination fee, appraisal, title insurance, and other fees.

Refinance fees add up to about $5,000 on average, according to Freddie Mac, and can be even higher depending on the loan and lender. This means you’ll generally need a hefty chunk of change on hand to refinance. A no-closing-cost refinance, however, allows you to skip paying those fees at closing — though you’re not entirely off the hook.

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How Does a No-Closing-Cost Refinance Work?

Despite its name, a no-closing-cost refinance doesn’t mean you won’t pay for any closing costs at all. After all, lenders want to recoup the cost of extending a loan to you.

“Costs are instead absorbed into the loan and repaid as part of the amortization schedule,” says Kevin Bazazzadeh, owner of real estate investment company Brilliant Day Homes in Houston.

If you’re considering a no-closing-cost refinance, be sure to ask about the specific terms of the loan, since “no cost” can be interpreted differently by lenders. Usually, these fees are reallocated in one of two ways:

  • The lender agrees to cover the closing costs in exchange for increasing your mortgage rate to make up for it. That higher interest rate will apply for the life of the loan, unless you sell the house or refinance again.
  • The lender allows you to roll the closing costs into your loan, so they add to your principal balance. That means you’ll pay the closing costs over time — with interest — as part of your monthly mortgage payments.

Keep in mind that it’s up to individual lenders to offer refinancing with no closing costs, so make sure to ask if a no-closing-cost refinance is even an option.

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The True Cost of a No-Closing-Cost Refinance

In theory, refinancing with no closing costs sounds like a fantastic deal. However, it’s important to understand that there’s no such thing as a truly cost-free refinance, as you’ll end up covering those fees one way or another. Here’s a closer look at how you might pay.

Higher mortgage rates

When the lender increases the mortgage rate to recoup its fees in a no-closing-cost refinance, the borrower enjoys savings initially but makes higher monthly payments than if they had paid closing costs upfront. That’s because the borrower is paying more interest with a higher mortgage rate. Over time, that extra interest adds up to the amount of the closing costs — and then some.

Let’s use an example with simplified calculations to show how a no-closing-cost refinance can be more expensive than paying closing costs upfront. Say you want to take out a 30-year mortgage for $300,000. The lender offers you a fixed interest rate of 2%, but you would need to pay $5,000 in closing costs. Alternatively, you could accept a 2.5% interest rate with no upfront costs.

If you choose to skip paying closing costs upfront, then your mortgage would have a monthly payment of $1,185, and you would pay $126,731 in interest over the life of the loan. If you elect to pay the closing costs as a lump sum, the monthly payment would be $1,109, and the loan would cost you $99,189 in total interest.

So, with no closing costs, you would end up forking over an extra $27,542 in total interest. That’s a significant difference, so paying the closing costs upfront would save you a lot of money over time.

Higher loan amount

Rolling closing costs into the loan principal results in a higher monthly payment than if the borrower had paid the fees upfront. The borrower also pays a greater amount of interest over time, since there’s a larger principal to accrue interest on.

Let’s use another example. Say you want to take out a 30-year mortgage for $300,000 at a fixed interest rate of 2%. Instead of paying $5,000 in closing costs upfront, you choose to bake the fees into the principal. With this method, the new principal would be $305,000. Your monthly payment would be $1,127, and the total interest paid would be $100,842 over the life of the loan.

If you pay the closing costs upfront instead, your principal would remain at $300,000. Your monthly payment would be $1,109, and the total interest paid would equal $99,189.

By going with no closing costs, you’d end up paying an extra $1,653 in interest, on top of the $5,000 added to the principal. Additionally, your mortgage payment would be $18 more every month. So, covering the closing costs upfront would help you save some money.

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Pros and Cons of a No-Closing-Cost Refinance

Choosing a no-closing-cost refinance can be beneficial in certain situations, especially if you don’t have a lot of money saved up. Even so, there are important drawbacks to consider.

Pros of a no-closing-cost refinance

There are several potential benefits to opting for a no-closing-cost refinance, including:

  • Refinancing sooner with less savings. One of the biggest perks of no-closing-cost refinancing is not having to pay a lump sum upfront. Out-of-pocket costs can reach several thousand dollars, which may be prohibitive for homeowners who want to take advantage of low interest rates but don’t have a lot of savings on hand.
  • Having money available for other goals. Even if you have the funds to pay for closing costs, you might prefer to use them for something else. For instance, if you have other high-interest debts — such as credit cards with large balances — then using your cash to pay them off first could help improve your financial situation.
  • Saving money overall. Even if you end up with a higher rate or paying interest on your closing costs, you can still save money in the long term with a no-closing-cost refinance if market rates are low.

Cons of a no-closing-cost refinance

On the other hand, a no-closing-cost refinance can wind up costing you significantly more. Here’s why:

  • You’re not actually getting a no-cost loan. Lenders recoup their costs through a higher interest rate or by charging interest on an increased principal. As a result, a no-closing-cost refinance can end up costing more than if you had paid those fees upfront.
  • You might need to pay for private mortgage insurance. If you roll refinance closing costs into the principal, then your equity may drop. If it falls below 20%, then you might be required to pay PMI, depending on the type of loan you’re taking out.
  • There might be a prepayment penalty. Lenders may charge a penalty for paying off your original mortgage ahead of schedule. With the additional interest paid on a no-closing-cost refinance, a prepayment penalty could wipe out any savings from refinancing.   

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Is a No-Closing-Cost Refinance Right for You?

When you’re thinking about whether to refinance with no closing costs, it’s important to consider if your financial situation will benefit enough from doing so. In particular, think about your goals, the new mortgage rate, how much you would actually save, and whether you’ll stay in the home long enough for refinancing to be worth it.

Make sure to review the loan estimate for each refinance offer. The loan estimate is a document that you receive within three days of submitting your application, and it breaks down all the costs associated with your loan. This will help you evaluate whether refinancing is the right move.

When to use a no-closing-cost refinance

Though a no-closing-cost refinance can result in additional costs over time, there are some situations when choosing this option makes sense. If you don’t have the savings to pay for closing costs upfront but there’s a pressing need to refinance for other reasons — when interest rates are especially low, for example — no-closing-cost refinancing might be right for you.

The key is to know how much a no-closing-cost refinance is going to cost in the long run. If you’re able to snag a low interest rate while it’s available, then paying $1,000 in extra interest from an increased principal can be a sensible exchange for thousands of dollars in overall savings.

Alternatives to a no-closing-cost refinance

If you’re wary of no-closing-cost refinancing, there are other paths you can take, even when you don’t currently have enough funds to pay for closing costs upfront.

If market interest rates are projected to stay low, one option is to delay refinancing and aggressively save for the next year or two to come up with the money for closing costs. Additionally, you can shop around for certain services, so there are opportunities to find a cheaper deal.

Another alternative is to negotiate with your lender about waiving some of the fees. While you probably won’t get all of them waived, the lender may be willing to skip some of the fees or reduce your closing costs.

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The Bottom Line on No-Closing-Cost Refinances

It’s important to understand that refinancing a mortgage is rarely — if ever — actually free. But if you play your cards right, a no-closing-cost refinance can work in your favor, depending on your financial situation. Just be sure you understand the rules of the game.