Many ‘cost-free’ loans have a prepayment penalty. This discourages you from refinancing during the loan’s initial years. Before agreeing, read the fine print, do the calculations and determine if you’ll move soon.
Lender pays the closing fees
This is a true ‘no cost’ loan, but you pay a higher interest rate. The lender makes the money back on the extra interest they charge versus what they would have charged if you paid the closing costs. Compare the total cost of the loan (upfront fees, interest, and any other fees) before deciding.
Wrap your closing costs into the loan
In this case, you pay the closing costs, but you finance them, so there’ no money out of pocket.
However, you pay interest on the closing costs since you increase your loan amount to cover them.
What is the Break-Even Point?
Knowing the break-even point is important. Is it one, two, three years, or longer? Total up your closing costs and compare them to the monthly savings. Divide the total closing costs by the savings and this gives you the break-even point in months. How does it compare to your plans? Is it worth it?
If you’ll stay in the home until it’s paid off, think about the total interest paid on both loans (current and new). Will you save in the long run by restarting the term?
Finally, look at the equity accumulation in both loans. If you’ve had your current loan for a while, a larger portion of your payment goes to the principal which means more equity. If you restart your term with a refinance, you go back to paying more interest than principal and decreasing your equity.