Is no-closing-cost mortgage for you?

Are closing costs keeping you from refinancing a mortgage? If so, a no-closing-cost mortgage may be for you. With this type of mortgage, you won’t need to pay thousands of dollars in upfront fees.

However, the trade-off for waiving those fees is a higher interest rate over the life of the loan.

“There’s two ways people achieve no-closing-cost mortgages,” says Bob Walters, chief economist at mortgage lender Quicken Loans based in Detroit. “The mortgage company will flat-out waive them, which doesn’t happen that often. Or, they will present the rate (with) closing costs and if you don’t want to pay, you’ll take a slightly higher rate.”

For example, you may be offered a mortgage with closing costs at a rate of 4.5 percent. Or, you can take a mortgage without closing costs at a higher 4.87 percent rate, Walters says.

When it pays off

Closing costs include things such as the loan origination fee, appraisal fee, and title search and title insurance fees. These costs vary from state to state, but on average the costs have been rising.

According to a 2010 Closing Costs Study, the origination and third-party fees on a $200,000 mortgage cost up to $3,741, marking a 36.6 percent increase from last year’s average of $2,739.

No-closing-cost mortgages are attractive to borrowers who simply don’t have the cash to pay fees upfront. These days, you generally need at least 20 percent down to qualify for a mortgage. Waiving the closing costs may be the ticket to getting a mortgage for a new home or a refinance.

If you don’t plan to stay in your home for more than five years, a no-closing-cost mortgage also makes sense. With a traditional mortgage, it could take more than five years to recoup the closing costs.

The slightly higher mortgage rate associated with a no-closing-cost mortgage is still likely less expensive over five years than what you would pay upfront in closing costs.

You need to look at the break even time frame.

Say, for example, you had a loan for a while at 6.5 percent and are only looking at being in the house for another four years. Then, you are probably a good candidate. You don’t want to put money down if you are going to be there for four years.

Also, on a refinance with no closing cost you could also offer to bring in the needed cash to set up you new escrow account for you taxes and insurance.  Thus you would simply be refinancing the exact current balance to a new loan with the same balance.  To really save money you can simply keep making the payment that you have been making.  Because of the lower interest rate your loan will payoff even soon than before you refinanced.

Also the advantage of doing this type of refinance is that your break even is immediate.  If rates fall further you can simply do it again.  Yes, if you stay in your home for a long time you could have saved more by paying the closing cost, but this way you have basically eliminated all the risk.

Paying a slightly higher interest rate to forgo closing costs may also make sense if you need the cash to do renovations on your home.

It likely would be cheaper to take the slightly higher interest rate to preserve the cash than to try and take out a home equity loan against the mortgage for home improvements, says Nate Moch, manager of Zillow.com’s Mortgage Marketplace.

When it doesn’t pay

Do you plan to stay in your home more than five years? If so, a no-closing-cost loan likely will end up costing you more than a loan with closing costs. That’s true whether you’re taking out a mortgage for a new purchase or refinancing an existing loan.

Typically, you’ll break even on your closing costs in a few years. Going with a no-closing-cost loan saddles you with a higher interest rate over the rest of the home loan. That could end up costing you a lot more than the upfront fees if you keep the mortgage for a long time.

As an example of two choices for a $150,000 loan: one has a rate of 4.125 percent with $6,000 in closing costs; the other has rate of 4.625 percent and no closing costs.

Going with the no-closing-cost option means you’ll pay more than $15,000 in additional interest on a 30-year loan.

No-closing-cost mortgages are available from various banks and mortgage brokers. Rates vary from one lender to the next, so it pays to shop around.

“It’s not something that every lender will offer, but it doesn’t hurt to ask about that option,” says Frank Nothaft, the chief economist at mortgage giant Freddie Mac. “It’s up to consumers to decide if the trade-off makes sense.”