The ERATE® Resource Guide to No-Closing-Cost Refinancing

by Amy Lillard

(6/8/2013) For the past few years, low interest rates have been a bright spot in an otherwise gloomy real estate market. In response to the economic debacle of 2008, the Federal Reserve has lowered interest rates to historic lows and kept them there, encouraging potential homeowners to buy. For this reason homeowners are looking to refinance into a better mortgage as well.

While refinancing may seem like a no-brainer in this environment, there is more to consider. In order for refinancing to save homeowners money and to help them obtain better loan terms, the decision must be based on personal finances and goals along with the costs a homeowner will incur. Ultimately, homeowners must make the determination whether refinancing is worth it and if a refinancing option that avoids closing costs is appropriate for them.

In this resource guide, we’ll take a closer look at the refinancing process, the different products available, reasons homeowners may want to refinance, elements of the decision, and the costs involved. Plus, we’ll examine the pros and cons of refinancing without closing costs, and a way to make the process simple, quick and effective.

Refinancing Explained

Whether you’re new to refinancing or have had experience, an overview of the process and why it’s beneficial is a helpful starting point.

Refinancing is the act of paying off an existing mortgage to replace it with a new one. Ideally, the new mortgage is an improvement on the old one in some way — a lower interest rate or better loan terms, for example. The goal of refinancing is to improve your mortgage by reducing the monthly payment and/or the amount owed in interest and principal over time.

What’s critical to remember is this: Refinancing doesn’t eliminate debt, it merely restructures it. While a refinanced mortgage may be a way to save money in the short and long term, it still means making payments each month along with all the other responsibilities of carrying a mortgage.

Refinancing in the Market

Refinancing is a hot topic these days for good reason. Interest rates are at historic lows, with monthly 30-year fixed-rate mortgages around 3.8 percent thus far in 2013, according to HSH Associates, the nation’s largest publisher of mortgage information.

As a result, more and more homeowners are looking to trade out of higher-interest-rate mortgages and capitalize on potential savings. Refinancing accounted for over half of all mortgage applications from mid 2009 to early 2011, according to Smart Money. In April 2013, refinancing was consistently around 75 percent of all mortgage applications, according to the Mortgage Banker Association (MBA) weekly survey.

Ultimately about 20.5 million homeowners who are current on loan payments have mortgages with rates above 5 percent, making them good candidates for refinancing to lower rates, according to CoreLogic, a leading provider of consumer, financial and property information, analytics and services to business and government.

Of course, the popularity of refinancing does mean there’s a backlog. According to Accenture, it now takes the nation’s biggest lenders an average of over 70 days to complete a refinance. This is in comparison to 45 days a year ago. And in truth, the majority of refinances take over 90 days.

Reasons to Refinance

Could refinancing be a good option for you? Generally, refinancing is accomplished in order to improve your current mortgage in one of three key ways.

Lower interest rate

Experts say that an interest rate reduction of even 1 percent is enough incentive to refinance. Why? Because refinancing to a lower interest rate accomplishes two things. First, it lowers your monthly payments. While one percentage point may not seem like a significant sum, it adds up. Consider this scenario:

Original mortgage = $225,000
Original interest rate = 5 percent
Original term = 30 years
Current monthly payment = $1208

In this scenario, let’s say the homeowner has paid down nearly $25,000 of the principal, and qualifies for a 4 percent interest rate. Using the refinance mortgage calculator at HSH.com, we can see the details change:

New mortgage = $200,000
New interest rate = 4 percent
New term = 30 years
New monthly payment = $955

At the same time, refinancing to a lower interest rate also reduces the amount of money spent over the life of a loan. In the example above:

Original loan: total spent over 30 years = $434,880
New loan: total spent over 30 years = $343,800

The difference can mean more money in your family’s pocket over time.

Better terms

Refinancing now, while the market has the lowest rates and slowly rising values, may allow you to get better mortgage terms to maximize savings and be more secure.

For example, homeowners with an adjustable-rate mortgage, in which the interest rate may vary over time, may take advantage of the opportunity to switch to a fixed-rate mortgage, in which you’ll know exactly how much you will pay each month and over the life of a loan. Experts are recommending that those who can get the favorable rates for a 15- or 30-year fixed-rate mortgage should, to lock in low rates and gain peace of mind. Homeowners are following suit. Among those refinancing in the last three months of 2012, 95 percent chose a fixed-rate mortgage according to Freddie Mac.

At the same time, refinancing provides homeowners the option to shorten their mortgage term. Shifting from a 30-year mortgage to a shorter one of 20 or even 15 years can shave a significant amount off of what you will pay over time. Plus, you’ll typically find lower rates on shorter-term mortgages. Consider this scenario, based on our example above:

Original mortgage = $225,000
Original interest rate = 5 percent
Original term = 30 years
Current monthly payment = $1208

Assuming again the homeowner has paid down nearly $25,000 of the principal, and qualifies for a 3.25 percent interest rate on a 20-year fixed-rate mortgage. Using the refinance mortgage calculator at HSH.com, we can see the details change:

New mortgage = $200,000
New interest rate = 3.25 percent
New term = 20 years
New monthly payment = $1134

In this scenario, monthly payments didn’t reduce by much. But, the amount paid over time drops significantly, to approximately $272,160 instead of $434,880.

Tap into Home Equity

There’s another benefit to refinancing that savvy homeowners take advantage of. Over time, the amount you owe on your property decreases and your equity, or ownership interest, increases. Homeowners can tap into that equity by refinancing for an amount greater than what is owed on the home. The difference is paid out in cash and can be used for things like home improvements, college funds, or to pay off debt.

Refinancing for Your Mortgage

The reasons to refinance a mortgage are many, and they’re pretty compelling. But experts advise that every situation is different. Before plunging into the fray, ensure refinancing is right for you by considering a few key things.

Your credit

Low interest rates are highly attractive and the prospect of getting rates below 4 percent a major boost for the refinancing case. But one thing to understand is that the best rates go only to people with the best credit. These days, with low rates and high demand, only those with credit scores of 720 or higher are qualifying for the rates in the three percent range, according to reports from Fox Business. Today’s mortgage consumer has an average credit score of 743, but scores above 680 can qualify for still low but relatively higher rates. And those with scores below that will have a very tough time qualifying for a rate that makes refinancing worthwhile.

Your financial situation and goals

What are you looking to accomplish by refinancing? If you’re looking to save money each month for a particular long-term goal, like financing a child’s college education or a retirement fund, the savings afforded each month may give you an easy sum to sock away. But if you’re facing a major life event in the next few months where you need to keep all cash in hand right now, like retiring or your child is starting college, refinancing may be best postponed. We’ll discuss why, in terms of the potential cash outlay involved in refinancing, later.

Your mortgage

The details of your current loan may mean more to think about when it comes to refinancing:

• If you’ve already refinanced the loan on your current home, experts advise rethinking another refinance. Some suggest that you should only refinance once during the life of a mortgage to avoid continually resetting the term on your loan thereby lengthening your repayment time and increasing your interest expense.

• If you’ve taken out a home equity loan or line of credit through refinancing, that could be another reason to hold off.

• If you’re nearly finished paying off your mortgage, with only a few years remaining, experts advise against refinancing.

• If you’re considering moving in the next few years, you should also hold off.

Your costs

Why do experts recommend against refinancing in certain situations, like those described above? Because when it comes down to it, the cost of refinancing may outweigh the savings you could realize.

Refinancing Costs

Wait — it costs to refinance a mortgage? Absolutely. Just like when you obtained your initial home purchase loan and had to pay closing costs, refinancing requires the same. Since you’re actually obtaining another mortgage to pay off the first, all the same fees apply again.

This cost is the main reason experts advise analysis and caution in refinancing. This is especially the case for those who are moving relatively soon, or are nearing the end of their loan repayment term.

Closing costs you could incur in refinancing include:

• Application — a fee for processing your loan request and running a credit check. Costs range from $70 to $300.

• Loan origination — a service fee or commission charged by lenders or brokers to originate and process the loan. This is typically amounts to 1.00- 1.50 percent of the loan amount. In addition to loan origination, some lenders may assess discount points (or prepaid interest to buy down your interest rate) depending on the loan amount involved.

• Appraisal — a fee for a professional appraiser to assess the value of your home. Costs range from $300 to $700.

• Inspection — a fee for a professional inspection, which may be required by lenders or state regulators. Costs range from $175 to $300.

• Attorney review — a fee for legal review of the contract, ranging from $500 to $1000 depending on the state where your property is located.

• Mortgage fees unique to loan type — a fee assessed for FHA, VA and other loans, or those requiring private mortgage insurance (PMI). This can range from 0.5 to 2 percent of the loan amount.

• Title insurance, escrow, transfer and insurance — fees for document searches verifying you own the property and no unwanted liens are present. Costs range bases on loan amount but can easily run over $1,000.

• Prepayment penalties — some lenders charge a fee for early payoff of a loan, amounting to 6 months of interest payments on average.

Ultimately, closing costs for a refinanced mortgage can total 3 to 6 percent of the loan, according to the Federal Reserve Board. A closing cost survey taken by Bankrate in 2012 indicated the national average for closing costs on a $200,000 home loan was $3,754. And that sum didn’t include the additional expenses that often have to be paid at closing, including property taxes, insurance, prorated interest and condo association dues.

Due to closing costs, it often takes at least two years to recoup the expense in the way of savings on your monthly payments.

So refinancing can involve hefty out-of-pocket costs. And that keeps many potential refinancers from taking advantage of the benefits it can provide. Enter a highly popular, but also highly misunderstood product: the no-closing-cost refinance.

Refinancing Without the Fees

At first, the no-closing-cost refinance sounds like it’s too good to be true. Savvy homebuyers and homeowners have seen their share of suspect real estate tactics, techniques and products, and this can initially sound like it belongs in that category.

But in reality, the term “no-closing-cost” is a bit of misnomer, resulting in some misconceptions.

As noted earlier, refinancing a mortgage requires the same fees that are associated with the purchase mortgage. Lenders still required fees for application and processing, an appraisal is once again required, title and escrow companies still require an escrow fee for transfer services along with title insurance. All refinanced loans require these services and incur these fees. So the cost remains somewhat similar to that of the purchase loan.

Loan amounts at or above $250,000 would typically be eligible for a no cost loan. Because the lender will use the rebate associated with the interest rate on the refinance to cover the closing costs, a loan amount of $250,000 would yield a 2% rebate amount and therefore an amount of $5,000 to cover the closing costs as well as the lenders own fees. Base closing costs on average run about $2800, so with a 2% rebate (or $5000) to the lender, they could cover both the base closing costs ($2800) on the loan as well as their own expenses and fees, leaving them with $2200 for their efforts.

Costs added to mortgage

To avoid paying all the associated costs at closing, those refinancing their home can opt to add these costs to the loan amount. It’s a simple process. Remember our example used earlier?

Original mortgage = $225,000
Original interest rate = 5 percent
Original term = 30 years
Current monthly payment = $1208

New mortgage = $200,000
New interest rate = 4 percent
New term = 30 years
New monthly payment = $955

In this scenario, closing costs would total approximately $4000. If you opted to tack these costs onto the mortgage, and avoid paying $4000 out of pocket at closing, here’s what the new loan details would look like:

New mortgage = $204,000
New interest rate = 4 percent
New term = 30 years
New monthly payment = $974

As you can see, using this option means the total loan will be bigger. As a result, the monthly payment will be slightly bigger, depending on the amount of the loan and the closing costs. It will also affect the amount of interest paid over the life of the loan.

Costs paid with higher interest rate

Another option available to homeowners refinancing who want to avoid paying costs at closing is to receive a higher interest rate. In our example above, if you opt for a higher interest rate instead of paying the $4000 at closing, the new loan details would look like this:

New mortgage = $200,000
New interest rate = 4.5 percent
New term = 30 years
New monthly payment = $1013

As you can see, this scenario results in a slightly higher monthly payment rather than folding closing costs into the loan - the interest rate will be higher for the entire life of the loan. The amount of interest paid each month and over the life of the loan will be larger. This will depend of course on the interest rate and loan amount involved.

When No-Closing-Cost Refinancing is Right for You

What’s the first step in knowing if this type of refinance option is right for you? Are you comfortable paying slightly more each month and over the loan term to avoid paying out-of-pocket closing costs?

There are specific situations in which this type of refinance might make the most sense for you:

• Moving soon. If you’re planning on selling your home in a few years, this type of loan could be highly useful. You’ll avoid paying the lump sum at closing that can take a bite from your finances, and you’ll still enjoy lower monthly payments than you’re currently paying.

• Paying off soon. Another advantage of the no cost loan is the elimination of interest rate timing. It is very difficult to predict when rates may drop again or hit bottom but with the no cost loan, a homeowner can receive immediate savings on their mortgage payment as well as the flexibility to take advantage of any future decline in rates should they wish to refinance again. The need to recoup closing costs would therefore be eliminated with the no cost loan. The key limitation in refinancing again would be the lender’s minimum seasoning requirement (typically 6 months) before the loan can be paid off again.

• Tapping into equity. If you’re refinancing in order to receive a cash payout of equity, this loan especially makes sense. You can take maximum advantage of money earned from the refinance, without cutting that sum by paying closing costs. Plus you’ll still reap the other benefits of refinancing

• Tax Considerations. A no cost loan is a way of covering the closing costs required to refinance by having a higher interest rate rather than a tacking them onto the loan balance and having a higher loan amount. Why would the higher interest rate be preferable to having a higher loan amount? Because generally speaking mortgage interest is deductible and any closing costs paid in a refinance transaction, unlike that of a purchase, must be deducted over the life of the loan rather than in the year they are paid as they would typically be in a purchase. See IRS publication 936 or consult with your tax advisor:

Ultimately, keep your refinancing goal in mind. If you’re looking to save each month, or pay less over the life of the loan, do the math. Will arranging for closing costs through a slightly higher loan or a higher interest rate get you there?

One caution about no-closing-cost mortgages: if you choose or are required to use an escrow account for taxes and insurance, a fairly common practice, you will typically still need to pay for several months’ worth at closing. In addition, you may be responsible for condo association dues in advance, which also must be paid at closing. In many cases it will be a wash — your regularly scheduled mortgage payment for the following month is skipped when refinancing and your property taxes and HOA dues are simply paid in advance. But it is important to remember that cash will be needed for these items at closing. Below is a comparison of the no cost loan vs., a zero point loan and a loan where one point is paid:

	No Cost Loan	Zero Point	One Point
Loan Amount	$ 250,000	$ 250,000	$ 250,000
Interest Rate - 30 yr.	4.50%	4.25%	4.00%
Monthly Payment	$ 1,266.71	$ 1,229.85	$ 1,193.54
Points	0	0	$ 2,500.00
Base Closing Costs	$0	$ 2,800.00	$ 2,800.00
Total Closing Costs	$0	$ 2,800.00	$ 5,300.00
Monthly Savings vs. a No Closing Cost Loan	N/A	$ 36.86	$ 73.17
Break-Even Point	N/A	6.33 years	6.04 years

As you can see, it takes a homeowner many years to break-even when either points or simply the base closing costs are paid in the refinance process versus the no-closing cost loan.

How to Find a No-Closing-Cost Refinance

The first step in the process is to fully understand it. . After reading this guide, you’re on your way!

If you’re looking at refinancing without paying out-of-pocket closing costs, there are a few key steps:

• Check your credit. Refinancing is more worthwhile if you can obtain at least one percentage point reduction in your interest rate. To qualify for some of these rates, you’ll need to have good credit and a relatively high credit score. Know where you’re at by checking your credit through free services. And if you could stand to improve your credit, pay down some of your debt, correct any credit report errors, and hold off on other purchases before attempting to refinance.

• Get at least 3 quotes. Contact three or more lenders for no-closing-cost refinance quotes. You’ll want to obtain a good faith estimate (GFE) that details the specifics of the proposed loan, and understand fully how the closing costs are being paid — either by a larger loan amount or a higher interest rate.

• Compare quotes. The federal Real Estate Settlement Procedure Act requires all mortgage lenders to use standardized GFE when providing quotes. That means you can more easily compare and contrast loan details and rates. Determine which quote works best for you on the metrics that are most important to you — monthly payment, rate, or loan amount.

• Apply for the loan. Just as when you applied for the initial home purchase loan, you’ll need to provide significant documentation regarding your income and finances. Be thorough and find all the documents required in order to ensure the lender has a complete picture of your ability to pay.

Using eRate.com for No-Closing-Cost Refinancing

You’re refinancing for a reason — to get a better loan that can result in savings. You’re choosing a no-closing-cost mortgage in order to maximize that savings. So the process outlined above is very important, particularly that of obtaining multiple quotes and comparing them.

There’s an easier way than reaching out to individual lenders and painstakingly comparing every line of the GFE. Using eRate.com, you can obtain multiple quotes quickly, and compare on the filters important to you easily. And from there, you can begin and push through the application process. The process starts here.

Remember — refinancing is a great way for you to improve your mortgage and save money, and refinancing without closing costs may be a way to maximize that savings. To learn more, visit eRate.com today.