Refinance: No Closing Costs vs. Lower Interest

Looking to refinance your home mortgage? You are likely to find hundreds of products offered by hundreds of thousands of lenders, each representing that they offer the best deal. “No closing costs!” “Lowest interest!” Comparing those no closing costs and lower interest rate deals can seem overwhelming but it can save you thousands of dollars over the life of your loan. Here’s how.

Start with the offers you’ve been given. You’ll need the estimated closing cost total as well as the interest rate and recurring annual fees. You will additionally need the monthly payment that is charged and a breakdown of interest and principal (search for “amortization schedule” using an online search engine if your lender does not supply one.)

The APR won’t help unless you are planning to keep your refinance loan through its full amortization. Most home loans, including refinancing loans, are for 30 years but Americans typically live in their home for just 7 years. The APR is an annual percentage rate including interest and all fees, spread out over the life of the loan, or 30 years.

Multiply your monthly payment by the number of months you believe you will stay in your home or the loan. If you plan on refinancing in 7 years, multiply your monthly payment by 84. Subtract the principal you will pay over the time you expect to be in the loan. This is the interest cost of the loan.

Add the closing costs, title fees and any charges not included in the closing costs. Excluded fees may be those associated with home inspections and appraisals.

Add the interest cost of the loan with all closing costs and excluded fees. This is the total cost of the loan. You can now compare how much the “no closing cost” deal saves or costs over the “lower interest” deal. Below is a comparison of two loan offers for a refinance of $100,000. The loan is expected to be refinanced in 9 years.

Smith Bank is offering an interest rate of 6.4%. There are no closing costs but they do charge 3 points, to be paid out over the first year of the loan. The monthly payment for the first year is $875 including the points, $625 per month thereafter.

Jones Bank is offering an interest rate of 6.1% with a 1% origination fee and an additional $2200 in closing costs. The monthly payment is $606.

According to the amortization schedules, payments over 9 years or 108 months will include $14,008.60 of interest for the Smith loan, $13340.72 interest for the Jones loan.

While there are no closing costs for the Smith loan, the points charged must be figured into the cost of the loan. Calculate this by multiplying the loan amount by the points. For this example, the math looks like this:

$100,000 x .03 = $3000

The origination fee for the Jones loan is calculated the same way, though they are only charging one point (.01) plus stated fees of $2000. The loan fees are calculated like this:

$100,000 x .01 = $1000 + $2200 = $3200

The Smith Bank loan offer will cost $3000 in points + $14,008.60 in interest, for a total cost of $17,008.60 over 9 years. The Jones Bank loan offer will cost $3200 in closing costs + $13340.72, for a total cost of $16,540.72 over 9 years.

If you plan on keeping the loan for a shorter period of time, say 2 years, the loan comparison works out this way:

Smith Bank - $2,340.38 interest + $3000 in points = $5,240.38 total cost

Jones Bank - $2,486.26 interest + $3200 in closing costs = $5,686.26 total cost