It’s tempting to go with a no-closing cost loan — after all, who doesn’t like free stuff? However, if it sounds too good to be true, that’s because it is. Before you accept a no-closing cost loan, you need to understand how they function, what concessions you’ll have to make, and whether or not it makes the most sense for your situation.
Depending on where you live, you will typically end up paying three to six percent of the value of your home in fees when refinancing. Closing costs are comprised of a number of charges, such as the application, credit check, origination, appraisal, title search, and legal fees.
Regardless of its name, you will be covering these fees when you take a no-closing cost loan — you’ll just be doing it in a non-traditional way. There are two approaches to writing a no-closing cost loan:
Either way, the lender will be making the same amount of money they would have with a conventional loan. While you’ll pay less upfront, your monthly payments will be higher and you’ll pay more over time.
Though paying extra each month is usually less than ideal, there are a couple of situations where it may be the preferable choice.
If interest rates are high and are projected to go down in the near future, paying large expenses out of pocket to lock in a high-rate loan doesn’t make sense. Simply pay a little extra each month until rates fall and you can refinance again. However, it’s important to be aware that this is a risky undertaking. You can never be 100 percent certain of the timing or extent of interest rate changes.
If you’ll be selling the house within five years, it might be prudent to trade closing costs in exchange for a higher monthly payment.
It’s not easy to drop a few thousand dollars upfront, but it’s worthwhile when you’re setting yourself up comfortably for the long term. Ensuring smaller monthly payments for years to come helps to protect you financially. Avoid no-closing cost loans if interest rates are low or you plan to keep the loan for more than five years.
Comparison shopping is extremely important when refinancing. Ask several mortgage brokers, banks, credit unions, and online lenders for a variety of quotes – both with and without closing costs. Once you have all of the options, you can determine which loan is the best for you.
If you’re still interested in a no-closing cost loan, spend some time running the numbers to be absolutely sure it’s the right choice. While the fees associated with refinancing can be steep, a no-closing cost loan is seldomly a bargain.