Is a No Cost Refinance Right for You?
06/08/09
Doing a refinance for no cost sounds like every homeowner's pipe dream. If you cannot afford to spend much when you first take out the mortgage, not having to cover mortgage fees sounds like an excellent way to make the loan affordable. But is that how it really works?
The trap with a no cost refinance, as with many types of refinance that seem like great deals on the surface, is that the fees are covered by a slightly higher interest rate. A traditional refinance usually has a lower interest rate than a no cost refinance. Over time, you may find that you pay more in extra interest than you would have paid in fees. (However, this needs to be balanced against the amount of money you save by doing any type of refinance. A no cost refinance may still give you considerable savings when compared to your current mortgage.)
Because of this trap, many refinance experts tell their clients to avoid a no cost refinance unless they can pay it off quickly, reducing the financial impact of the higher interest rate. There are also several other reasons you might want to take a no cost refinance with a higher interest rate. Perhaps you do not have the money to cover higher closing costs now, but you foresee improved income in the near future and want to take advantage of lower interest rates now. Or maybe the higher monthly payments are offset by tax advantages triggered by the higher interest rate. And when interest rates in general are low, even the slightly higher interest rate on a no cost refinance may be an excellent deal. In that case, taking out a no cost refinance immediately, rather than waiting until you have the money on hand to do a traditional refinance, would be a sound financial move. Getting a good deal in refinancing, just like buying real estate or taking out a first mortgage, relies on timing and your personal situation as much as on the results of any financial formula.
Given these pros and cons, is a no cost refinance a good option for you? Weigh your available offers and run them through a mortgage calculator. Realistically determine whether you will be able to pay higher monthly payments or add a little money to each lower monthly payment to shorten the term of your refinanced mortgage. Consider whether there is a less expensive way to raise the money for the refinancing fees. If a no cost refinance is indeed your best option, go into it with a full understanding of the pros and cons of this kind of refinancing. You can make a no cost refinance work for you.
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