Cash Out Refinance: No Closing Costs vs Lower Rate

by Kathy from Evansville, Indiana

Ask Kate about a cash out refinance: No closing costs vs lower mortgage rate. Kathy needs to refinance to put a new roof on her house. She is three years into her 15 year mortgage and prefers to stick with the same term. But she questions which is better, no closing costs or a lower interest rate.


15 Year Mortgage Refinance: No Closing Costs vs Lower Rate

By Kathy from Evansville, Indiana
Cash Out Refinance: No Closing Costs vs Lower Rate

Kate,

I am looking into refinancing my mortgage with $15,000 cash out to use for home repairs (new roof, etc.).

I have $35,400 and 12 years (of a 15 year loan) remaining on my current mortgage with an interest rate of 3.75%.

I can refinance with my current lender with no closing costs, but an interest rate of 3.875% for 15 years.

Another lender has a 15 year mortgage with an interest rate of 3.125%, 0% origination fee, plus closing costs.

All the refinance calculators I have used show that I would be paying more interest over the life of the loan by choosing the no closing cost loan.

Which would be the better option--paying the closing costs (which could probably be added into the loan), or paying the higher interest rate?

Ask Kate at Get-Your-Best-Mortgage-Rate.com
Ask Kate answers: 15 Year Mortgage - No Closing Costs vs Lower Rate

Hi Kathy,

Before we look at the two options you mention (no closing costs vs lower interest rate), have you thought of applying for a 2nd mortgage?

Not given out like candy by the major banks these days, the loan program does still exist for well-qualified borrowers.

The reason I bring up a 2nd mortgage is because you already have a low rate of 3.75%. Additionally, you are into the fourth year of your 15 year mortgage. That's more than 20% of your entire term!

But by refinancing, the amortization schedule starts over. This means the first three years are repeated when a greater amount of interest is paid. As an example, look at the amortization schedule of this sample 15 year mortgage.
15 Year Mortgage Amortization Schedule
Okay, moving on...

Cash Out Refinance: No Closing Costs

One of the refinance options presented to you charges no closing costs. But in turn, this scenario charges a higher-than-market interest rate. Between the increases to the rate and your loan amount (for taking out cash), your monthly payment is going to be higher. If you choose this option, make sure the payment is affordable!

Generally speaking, homeowners can come out ahead with a no closing cost offer if they do not plan on keeping the mortgage for more than few years. But as you found out when you ran the refinance calculator, a no fee program ends up costing the borrower more interest over the term of the loan in contrast to the second offer you received. (More on this in a moment.)

Word to the wise, when accepting a no closing cost loan program, double-check that there are no prepayment penalties! I explain prepayment penalties at Adjustable Rate Mortgage - How To Avoid Surprises.

Cash Out Refinance: Lower Mortgage Rate

On the other hand, paying for closing costs increases the amount you are going to borrow if the fees are rolled into the loan balance. But typically, assuming the mortgage fees are reasonable and the interest rate is low enough, this could be a good option if you plan to keep your mortgage until it's paid off... or at least for more than five or ten years.

How do you know if the closing costs are reasonable? To make sure your bank is playing fair, go to Mortgage Refinance Costs: Bank Reluctant to Disclose Fees.

No Closing Costs vs Lower Mortgage Rate

As you can see there are pros and cons to both loan options discussed. There's not a right way or a wrong way. But in general, by considering the affordability of the monthly payment and how long you plan to keep the mortgage, borrowers can make good decisions.

I also encourage you to ask the two loan representatives which plan they recommend based on the details of your refinance. This is because individual qualifying factors, for example, appraised value and debt-to-income ratios, need to be taken into consideration when choosing between loan programs.

More Refinancing Answers to Homeowners' Questions

Are you trying to decide if refinancing your mortgage is worth the cost? Go to Mortgage Refi Tips for no-nonsense answers.

Are you wondering why your cash out refinance hasn't been approved? After all, it's your equity you are asking to borrow! Yet if you have ever been in this position, you'd probably agree that the bank wants to see you beg... Refinance with Cash Out and Avoid the Woes.

Scott's banker offered these 3 refinancing options, a no cost refi, the best mortgage rate, or the lowest monthly payment. But Scott admits to total confusion! Here's my take... Mortgage Refinance Options: No Cost vs Best Rates.
Best wishes,

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