For most of our clients, the idea of a “no closing cost” (NCC) refinance seems too good to be true. We think that these loans are great tools for helping our clients save money; but it is critical that our clients understand how they work. The purpose of this posting is to explain how we can offer NCC refinances and how we use them to help our clients manage their mortgages most effectively.
The first thing to understand when it comes to NCC refinances is how they are even possible. As a mortgage lender, there are two ways in which we can generate revenue for our work in originating a new mortgage. The first and most common way is by charging an origination fee to our clients, also known as “points”. Some lenders charge a 1% point in addition to standard closing costs (lender, appraiser, title/ escrow, etc.).
The second way we can generate revenue is by selling the servicing rights of a loan we originate. In other words, lenders are willing to pay us a fee in exchange for the stream of payments that our clients pay as a part of their mortgage obligation. NCC refinances become possible when we can use the revenue from the sale of the servicing rights to cover all of the closing costs that our client would normally incur.
So what is the tradeoff? The tradeoff is that in order to generate enough revenue to make a NCC refinance feasible, we have to assign a premium to the interest rate above what a borrower could lock in if they were willing to pay their own closing costs.
As an example, here is list of available 30 year fixed rates with the associated closing costs:
4.75% w/ $3,500 closing costs + 1% point ($3,500)= $7,000 closing costs
5.00% w/ $3,500 closing costs
5.25% w/ $0 closing costs (in fact there is a $3,500 lender credit that is used to offset the $3,500 in costs)
For most of our clients it can be difficult to justify the standard closing costs associated with a refinance because the fixed rate being offered is only modestly better than their current situation. For example, for a client who has a current fixed rate of 5.50% the 4.75% would only create approximately $3,000 in annual interest savings & the 5.00% option only about half that. A borrower would need to hold the mortgage for over 3 years in order to save enough interest to recoup the closing costs associated with these options. For most people the “break-even” period is simply too far away to make the proposed refinance attractive.
However, this person could take advantage of our NCC refinance option @ 5.25% and immediately begin saving approximately ~$800 per year. This amount would not change their life but the fact that they incurred $0 closing costs to obtain the new rate would make it beneficial to them from day 1.
Here are some FAQ’s we’re commonly asked about NCC refinances:
Should we wait to see if rates go lower?
The best part about NCC refinances is that typically we can continue to provide them. If a borrower took advantage of the aforementioned 5.25% option and rates continued to decrease over the following months we could always provide another NCC refinance in the future. Since there is no cost to them there is no drawback in doing it multiple times, even within a short time period. We call this the “ratchet effect” because we effectively “ratchet” your mortgage rate lower as long as it makes sense but the rate will never move higher from the fixed point.
Will we have to bring any cash into closing?
It is likely that you’ll have to bring some money into closing. The amount will vary on a case-by-case basis but lenders will essentially collect what equals to one mortgage payment because by refinancing you’ll skip your next one. For example, if you closed the NCC refinance on June 15th you’d be responsible for the interest on your current loan from the date of your last payment (June 1st) to the 15th (when the loan would be paid off). You would also be responsible for the interest that will accrue on the new mortgage from the close date, to the last day of the month (June 15th –June 30th). You WOULD NOT have to make a mortgage payment on July 1st.
Depending on whether or not you pay your real estate taxes & homeowner’s insurance with your monthly mortgage payment, the lender may also need to collect funds to re-establish a tax/ insurance reserve account. Often times these amounts can be included in your new loan amount so that you don’t have to fund this with cash out of your pocket. Keep in mind that when you pay-off your existing mortgage the lender will refund any amount that you currently have on deposit with them and therefore this amount that is collected is effectively a “wash”.
If you pay your real estate taxes and homeowner’s insurance separate from your mortgage payment then the lender may require that your current homeowner’s insurance be renewed (if it set to be renewed within the next few months) or any outstanding real estate tax liens be paid (depending on the time of year).
Will my loan amount change?
Some of our clients have asked us if when talking about a NCC refinance we are simply referring to “rolling” the cost of the loan into the new loan amount. We are not. This is truly a NO CLOSING COST refinance. If you’re comfortable paying your equivalent of one mortgage payment at closing and possibly any collected taxes and insurance then we can keep your loan amount exactly the same.
Does my 30-year term on my mortgage start over again?
It is true that with the new mortgage your term will start over again (there are some exceptions). However, if paying off your mortgage is most important to you then it would still be in your best interest to complete a NCC refinance. This is because if you used the monthly payment savings that you’ll get from the refinance to pay additional principal each month you’ll pay off your principal quicker than your current mortgage with a higher interest rate.
Are NCC refinances available to everyone?
NCC refinances are tougher to offer for borrowers who have loan amounts < $250,000.