Refinancing a mortgage can be attractive for a variety of reasons. Homeowners often save money by refinancing when interest rates are lower than what they’re currently paying. A cash-out refinance can allow them to tap into their home equity to pay for home repairs or consolidate debt. Or they may want to switch from an adjustable-rate mortgage to a more predictable fixed-rate one.

Whatever the motivation, it’s important to consider the closing costs, including whether a no-closing-cost refinance could be the right choice.

What Is a No-Closing-Cost Refinance?

Mortgage refinancing isn’t that different from getting a mortgage in the first place. For example, the borrower can expect to pay closing costs on the loan. They can include things like:

• Government recording fees
• Appraisal fees
• Credit report fees
• Origination fees
• Survey fees
• Tax service fees
• Attorney fees
• Underwriting fees

According to Freddie Mac, refinancing typically involves closing costs of approximately $5,000.1 As with other home loans, these closing costs would ordinarily be due when you sign the paperwork to finalize the new loan.

A no-closing-cost refinance doesn’t require you to pay these fees out of pocket. But that doesn’t mean there are no closing costs at all. Rather than having you pay them at the loan closing, lenders can collect these costs in one of two ways:

• Charging a higher interest rate on the new loan
• Rolling the closing costs into the new loan’s principal2

Either option will affect the total cost that you pay for the new mortgage.

How a No-Closing-Cost Refinance Works

If your lender offers no-closing-cost refinancing, you may be given the choice of paying a higher interest rate or having the closing costs rolled into the new loan. Here is how each one works and how they’ll affect your costs.

Option 1: Pay a Higher Interest Rate

Choosing a no-closing-cost loan with a higher interest rate will mean a larger monthly payment and affect the total amount that you’ll pay over the life of the loan.

For example, say you have 25 years remaining on a 30-year, 4.2% mortgage and you currently owe $250,000. Because you want to reduce your monthly payments, you decide to refinance into a new 30-year loan at 3.2%. Closing costs are estimated at $5,000, and you decide to pay them out of pocket. The new loan will reduce your current monthly payment by $141—from $1,222 to $1,081.

Now, suppose that you can’t or don’t want to pay closing costs out of pocket but agree to a 3.7% interest rate instead. In this case, your payments would be only $49 a month less than your old mortgage.

Option 2: Roll Closing Costs Into the Loan

Rolling the closing costs into the new loan means adding them on to the loan’s principal. While the lender may offer you the same interest rate as if you were paying the closing costs out of pocket, this option will still increase your monthly payments and lower your total savings.

Using the same $250,000 mortgage scenario as above, assume that you roll the $5,000 closing costs into the new 3.2% mortgage. (Now you’re borrowing $255,000 rather than $250,000.) By choosing this option, you would reduce your monthly payments by $120 compared with your old mortgage. That’s $21 a month less of a reduction than if you paid the closing costs out of pocket.

While all of these scenarios show that you can save some money on your monthly payment by paying closing costs out of pocket, you either may not have that much cash on hand or may have other uses in mind for it. Another way to look at the situation is how long it will take for the money that you save each month to add up to the amount that you spent on closing costs. For example, if you reduce your monthly payment by $141, as in the example above, then it will be just over 35 months, or about three years, before your savings come close to $5,000.

Pros and Cons of a No-Closing-Cost Refinance

A no-closing-cost refinance can have both advantages and disadvantages for most homeowners. Here are some you’ll want to consider.

Pros Explained

• Refinance without paying closing costs out of pocket. A no-closing-cost refinance allows you to preserve your cash for other purposes.
• Cash out home equity. You can use a no-closing-cost refinance to pull equity from your home that you can then use for repairs or other expenses. While you can do that with any kind of cash-out refinancing, a no-closing-cost loan will mean that you’ll have more cash available.
• Lower interest rates can still save you money. Even if you’re paying a slightly higher rate for a no-closing-cost refinance than you would if you paid those costs up front, you could still save money over the life of the loan based on the difference between your old and new loan rates.

Cons Explained

• You’re not avoiding closing costs. A no-closing-cost refinance loan doesn’t mean these costs go away entirely; you just don’t pay them up front.
• Monthly payments could be higher. Depending on the new loan term that you choose and the interest rate for which you qualify, your monthly payments could be higher with a no-closing-cost refinance loan than with your current loan.
• May take longer to break even. The breakeven point represents the point at which any money you paid toward closing costs, either directly or indirectly, is recouped in interest savings on the loan.

The Bottom Line

No-closing-cost refinancing can be attractive for homeowners who want to refinance their mortgages without spending much money out of pocket. Whether no-closing-cost refinancing makes sense for you can depend on a variety of factors, including:

• How much money you hope to save on interest
• The interest rates for which you’re able to qualify, based on your credit and income
• How long you plan to stay in the home
• Whether you choose to pay a higher interest rate or roll closing costs into the loan

If you’re considering a no-cost refinance or regular mortgage refinancing, take time to shop around and compare the best mortgage rates. This can help you find the best loan terms for refinancing your home.