Little-Known Perks of Going for a No-Cost Mortgage Refinance

If you have a home mortgage, you may want to refinance it if you can get a lower rate or better terms than you have on your current loan. Usually, though, refinancing means you get stuck paying closing costs out of your checking account. These costs could add up to around 2% to 6% of your loan's value, which is a lot of money -- as much as $18,000, if you're borrowing $300,000.

If you want to tap the equity of your home and don't have that much cash to pay out, you do have another option: a no-cost mortgage refinance. With this loan type, you wouldn't have to pay upfront -- although you would have to cover the closing costs over time.

There are some benefits of choosing a no-cost mortgage refinance loan that are worth considering, however.

1. You have more flexibility in how you pay your closing costs

If you pay your closing costs upfront, you don't have any options -- you just pay the money when you close on your loan. But if you choose a no-cost refinance loan, you have two choices:

1. You can borrow the money for the closing costs. With this approach, you simply roll the costs of closing into your loan, increasing the borrowed amount. So, in our above example, if you were taking out a $300,000 loan and paying 6% closing costs, you'd actually take out up to a $318,000 loan.
2. You could pay a higher interest rate. Many mortgage lenders will offer no-closing-cost mortgage refinance loans by covering the closing costs through charging you a higher interest rate.

The added flexibility of being able to choose which option makes sense for you is beneficial. If you want to make a lump sum payment of your closing costs later, you could just roll them into your loan, for example. But if you think you'll refinance again soon, you could opt for the higher interest rate, since you might not have to pay the extra costs for very long.

2. You may end up paying less in closing costs over time

In some cases, if you opt for a no-cost mortgage refinance and accept a higher interest rate to cover the closing costs, you could end up paying less over time.

The table below shows two possible scenarios if you take out a $300,000 refinance loan with a 30-year repayment term and closing costs of 2% (the low end of the range).

If you chose the loan with the higher interest rate and no upfront costs and you refinanced or sold your house in three years, you'd have paid $3,662.28 in extra payments -- which is less than the $6,000 in upfront closing costs you'd have incurred.

3. Your closing costs could end up costing less in real terms

The last little-known perk is that when you roll closing costs into the loan or accept a higher rate rather than paying upfront, you end up paying them off with money that's worth less in real terms thanks to the impact of inflation.

As time goes on, your money is worth less as prices go up. For example, the $6,000 that you spend on closing costs today will actually buy you only $4,687 worth of stuff in 2033. That means that each month you make your mortgage payment, it costs you a little less in real terms. So instead of paying your closing costs with today's money, you're paying it with less-expensive future money, meaning it doesn't cost as much in real terms even though the payment stays the same.

For all of these reasons, you should carefully consider whether a no-cost refinance is right for you. Just be sure, when you compare loan offers, that you look at both monthly payments and total borrowing costs over time so you can make an informed choice.