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?
Thanks for the write up – i didn’t explore a no cost refi
They are offering to roll our closing costs into the cost loan and even will roll the escrow amount in if we want (which we definitely are not doing)
Definetely agree with you the the amount of time you plan on owning the home should be a factor in this process
6k for a little up front work is a great move – nice work
We were one of those people who did a refi and then ended up moving about a year later. Moving wasn’t even on the radar but sometimes life happens. It was a substantial rate decrease but I’m sure the numbers didn’t work out in our favor. Win some and lose some 🙂
We actually ended up doing something similar with our first home, which added to our trepidation in acting before we discovered the no cost option.
I paid off my house in 2012, but chose to refi back in 2009. We were able to also drop a full point and the breakeven for us was 22 months.
You are smart to drop down from a 30 to 15 year mortgage especially in light of the cheap interest rate environment. On top of that savings $6k. That’s awesome. Congrats on the refi!!!
Thanks. I keep alternating on paying off versus investing depending on my feeling about the markets any given month. Thats a post for another day though 😉
I think people overestimate the hassle and the amount of work in a refinance. If you do the calculations and come out ahead, then I say go for it!
Very true. The worst part of the whole thing was printing out a bunch of pieces of paper and signing them. Was that worth 6K? Definitely. Thanks for stopping by.