Understanding A No Cost Refinance

With mortgage rates continuing to fall, many homeowners are looking at refinancing options. Unfortunately, refinancing can be expensive, and unless you're planning on staying in your home for a very long time, the long-term benefits may not outweigh the upfront costs. Be that as it may, refinancing doesn't have to cost you an arm and a leg. 

With a no cost refinance, homeowners can take advantage of a lower interest rate with few or no out of pocket costs. As the name implies, a no cost refinance is a refinancing option in which the lender pays the closing costs.

In order to understand how this works, it's important to have a general understanding of how interest rates are calculated. One myth is that there is one "rate" for any given point in time. The better way to think of it is that there are several rates, each one associated with points. In simplest terms, lower interest rates are more expensive up front - i.e., they require the borrower to buy points. 

The other option is to have the mortgage bank or lender buy points for you. This will mean accepting a higher interest rate, but as long as that rate is still lower than what you're currently paying, you will come out ahead. 

To illustrate:

Say your current interest rate is 5.5% and you want to refinance. You could either switch to a 4.25% interest rate and pay no closing costs whatsoever, or your could "buy" a lower interest rate, say 3.75%, for thousands of dollars.

The bottom line: A no cost refinance makes a lot of sense in a low interest rate market. With essentially no risk involved, you can always refinance again if rates drop substantially in the future.  

Before you plunge into a no cost refinance, here are a few things to keep in mind:

* No cost refinancing is not for everyone. Talk to a trusted mortgage consultant to find out if this is the best option for you.

* If you are escrowed for insurance and taxes, you will be required to open an escrow account for the new loan, which will probably require some cash up front (usually 6 months worth of taxes and insurance, but amounts can vary). Don't let this scare you - generally your current escrow balance will be refunded to you within 30 days of closing. If you absolutely cannot afford to put any cash down for escrow, talk to your loan representative about other options such as rolling them into the loan amount. 

* Unless you are doing a streamlined refinance of an FHA or VA loan, you will most likely need an appraisal to refinance.

For more information, talk to a few mortgage professionals in your area. Don't get information from only one source. Scout around and do some homework. When you do speak with a mortgage consultant, he or she should be able to advise you on the best course of action when it comes to refinancing.