Contrary to what many people think, refinancing for a lower rate won’t necessarily save you money in the long run. A mortgage loan is *more than just the interest rate*. In other words, when evaluating whether or not a new mortgage will benefit you, it’s important to dig deeper than just comparing the new rate to your old one. Yes, the new interest rate may be lower than the old one, but that doesn’t mean it’s actually saving you money!

To illustrate the point, consider John, who is shopping around to refinance his mortgage. John’s goal with refinancing was not to reduce his payment, but to pay off his home fast and keep his interest bill as low as possible. His existing loan is a 15-year fixed financed at 4.75% with 7 years left before it is paid off. With a new 10-year fixed loan, he can get a 3.375%.

At first blush, this sounds like a pretty good deal, right? A shorter loan term and a big rate reduction should be a no brainer, right? Not necessarily! Let’s look more closely at the numbers:

**Current 15-year Fixed Loan**

- Start date: 8/1/2003
- Original balance: $245,000
- Interest rate: 4.75%
- Principal and interest payment: $1,905.69
- Remaining Balance: $128,557

With a little less than 7 years left, John has $21,992 in interest *remaining *on his current loan – assuming he makes just his regular payment for the remainder of the loan term. Now, let’s take a look at the numbers on the new 10-year loan:

**New 10-Year Fixed Loan**

- Start Date: 2/1/2012
- Starting Balance: $134,000 (to cover closing costs and escrow deposits)
- Interest Rate: 3.375%
- Principal and interest payment: $1,317.24

Though John can get a much better interest rate, he isn’t actually saving any interest over the life of the loan by refinancing. The total interest bill on the new loan over the next 10 years is $24,068, which is $2,076 *higher *than what he has left to pay on his current loan. Closing costs are $2,893, so the new loan puts him in the hole nearly $5,000 to get that 3.375% 10-year fixed.

Even if John makes extra payments on the new loan to keep him on the same payoff schedule he has now (7 years), he still doesn’t save a whole lot. Paying off the new loan in 7 years reduces the total interest bill by $5,353, but when you add in closing costs, net savings are only $2,460 over a 7-year period – a mere $351 per year.

Again, a loan is much more than an interest rate, so it’s important to run the numbers and make sure a new loan truly benefits you. A better interest rate doesn’t necessarily mean you’ll actually save money in the loan run.

## What Exactly Is a “No-Cost” Refinance?

You probably see ads all the time for “No-Cost Refinancing”, but what exactly is it and how do some lenders offer it and some don’t? The truth is, all lenders can offer it and probably do, and it’s just that some use it as a marketing gimmick.

A *true *no-cost refinance is one in which the lender literally picks up all of the fees, with exception to your escrows (assuming you have escrow taxes and insurance) and pro-rated interest. So you don’t pay any fees; no appraisal, no credit report, no title search, nothing.

So how does the lender do it? Understanding this requires knowing how lenders are compensated. Most lenders are compensated by the banks and mortgage companies to whom they sell or broker loans. Typical compensation for a lender who wants to be competitive is .75 – 1% of the loan amount. This means that for a $200,000 loan, the lender would be paid $1500 – 2000 for originating the loan. Each day, lenders receive rate sheets from all of the banks and mortgage companies showing what the compensation is at different rates. So if at 6% the lender is getting paid 1%, then at 6.125% they would be paid approximately 1.5%, and at 6.25% they would be paid approximately 2%. As you can see, the higher the rate at which they lock you into a mortgage, the more they are paid.

That is where the no-cost refinance comes in. Whereas a traditional refinance involves a locked rate based on specific closing costs, the no-cost refinance is at a higher rate with *no *closing costs. The lender actually quotes you a higher rate and uses the compensation to pay for the closing costs. Using the example above, at 6.25% the lender is getting paid $4000 by the bank or mortgage company for originating your loan. If the total closing costs are only $1600, the lender nets $2400 compensation from your loan, and you paid nothing to do it. Or did you?

You see, you haven’t yet, but you will. That’s because when you choose a no-cost refinance option, you’re getting a rate that is .25-.375% higher. So you’re basically financing the closing costs in the interest rate, something that can add up over time. Let’s take a look at an example. The interest on a $200,000 loan at 6% = $1000/month and a $200,000 loan at 6.25% = $1041.67. So the difference between the traditional refinance and the no-cost refinance is $41.67 higher each month. That means that if closing costs run $1600, you would start losing on this option after 38 months, which is the break-even ($1600/41.67=38.4).

So longer term a no-cost refinance may cost you a lot more that what it might have costed you if you had paid all the closing costs from your own pocket. Do a comparison analysis and carefully make the right choice on your next mortgage refinance.