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No Closing Cost Refinance

Any loan where the broker or lender pays all of your closing costs is commonly referred to as a ``no closing cost'' loan. These closing costs would include title & escrow fees, appraisal, lender's fees, credit report fees, and other expenses which are non-recurring over the life of the loan. Lender's use the term non-recurring to refer to only those expenses which are one time, and to exclude items such as interest, insurance, and property taxes, which are considered recurring closing costs because they will continue to be expenses every month. Recurring costs are not covered expenses in a no closing cost loan.

In the mortgage market, there are a variety of interest rate and point combinations available to the borrower at any point in time for the same product or loan type. As an example, for a loan amount of $200,000 a borrower can be quoted 6.75 percent with .875 percent points, 7.0 percent with zero points, or 7.25 percent with no closing costs. All three of these quotes are for a 30 year fixed rate mortgage. The lender allows the borrower to choose amongst rate and point combinations since some people prefer a lower rate immediately, while others prefer minimizing how much they pay out of pocket up front. Thus, the borrower can select the combination which feels most comfortable to their personal situation. For some borrowers, the no closing cost option of 7.25 percent, while providing a slightly higher rate, still requires the least investment up front and therefore is the best option.

A true ``no closing cost'' loan differs from both a ``no lender fee'' loan or a loan in which the lender adds the closing costs to the amount financed. A ``no lender fee'' loan, sometimes advertised by banks, usually will not cover the title, escrow, and other outside charges you may need to complete the refinance or purchase.

No cost loans will always carry a slightly higher rate than a loan that does not pay your costs. In general, a no cost loan is the better strategy if you plan to keep your loan for the next one to three years. Longer than that, you should consider paying the costs yourself to get a lower rate since over time the lower interest rate will save you more money. And if you plan to keep the loan for four to five years, it often makes sense to pay closing costs and points to get an even lower interest rate. (Points are up-front mortgage interest fees paid on a loan to reduce the initial interest rate.)

Very recently, the emergence of multi-lender mortgage sources with lower overall cost structures have made no closing cost loans at lower rates easier to obtain. As greater efficiencies are achieved and fees and costs are reduced further, consumers should see no closing cost loans become available at even lower rates.

No Cost Refinances

No closing cost loans can be used for either a refinance or a purchase transaction, although they are most commonly associated with a refinance. A no cost refinance is the quickest way to generate immediate interest rate and payment savings with no up front investment in closing costs. To continue with an example, let's assume that a borrower is currently at 7.5 percent on a 30 year fixed rate loan and is interested in refinancing when interest rates are declining. But what is the best time to finally ``bite the bullet'' and lock in a rate? If the person chooses to refinance using the no closing cost method, it doesn't matter when they lock in, so long as they are immediately saving money by refinancing. By choosing the 7.25 percent no closing cost loan, their payment would decrease right away, with no up front investment to refinance. Should interest rates continue to decline, the borrower can simply refinance again to obtain additional savings.

With a true no closing cost loan, you can refinance for any incremental drop in your interest rate. Because there is absolutely no investment in up front costs, the savings of refinancing are immediate. In a market where you believe rates may continue to fall, it makes sense to refinance at no cost. Should interest rates decline further, you can refinance again without having to recoup the closing costs. Many borrowers refinance every year or less at no cost, while keeping their initial teaser rate in an Adjustable Rate Mortgage!

Tax Issues - Refinance

A no closing cost loan will not have points, and thus no deduction for that cost. But the loss is trivial. In a refinance transaction, points must be amortized over the life of the loan. For example, on a 30 year loan, you can deduct 1/30th of the points paid each year. If you refinance for a second time, however, you can deduct the remaining unamortized points in the year you refinance the loan. Consult your tax advisor for more information.

No Cost Purchases

In a purchase situation a no closing cost option can work extremely well when the borrower has limited funds available for closing or when the rate market is declining and the borrower may want to refinance quickly. No closing cost loans can be used effectively to free up more cash for the down payment or save for repairs or other uses. If the seller can not credit for closing costs (due to low equity or other reasons), a no closing cost loan is the next best alternative.

In some cases no closing cost loans can give a borrower more cash than is needed for the direct closing costs. As long as this does not exceed the lender's guidelines (typically 3 percent of the purchase price in overall credits), this cash can be applied to other costs in the transaction.

Tax Issues - Purchases

While most people associate a purchase with paying points just to obtain tax deductibility of the points, this is too simplistic a view. While the tax deductibility is an important factor, it is only one consideration for a borrower. Paying points up front to secure a low rate, in a steadily declining interest rate market, may be simply throwing money away. If the borrower decides to refinance shortly after a purchase, the points and costs paid up front will be a wasted expense.

A no closing cost loan will not have points, and thus no deduction for that cost. Additionally, the other costs are paid for and no deduction is available. If you are purchasing a home, points and some costs are generally entirely deductible in the year you buy. This is true even if the seller is paying for your points.

In summary, no closing cost loans can be used successfully in either a refinance or a purchase loan. These loans will minimize the up front closing costs that you pay, and are generally best used in a stable or declining interest rate environment. By carefully using this type of strategy, a borrower can continue to replace his home loan without incurring costs or increasing the outstanding principal balance of the mortgage. Stiff competition among mortgage services have driven down the costs associated with obtaining a loan, and thus lower interest rates are now available at no closing costs to the borrower.

Hal Schupp, CRS, GRI, Designated Broker for Vail Realty, has been a Tucson, Arizona, Licensed Real Estate Broker since 1987 and has created 100s and 100s of sales of Tucson properties.