Are you looking to refinance your home, but are trying to get a loan with low upfront costs? If so, you may be eyeing no cost mortgages. Before you sign on the dotted line make sure you understand the pros and cons of no cost mortgages.

What is a No Cost Mortgage?

If a lender offers you a no cost mortgage, they are offering you the chance to refinance a loan without paying any fees or charges upfront. The lender pays these fees for you. This loan is also often referred to as the No Points No Fees (NPNF) Refinancing.

Is a No Cost Mortgage Really No Cost?

The name “no cost” mortgage is really a misnomer. All lenders charge closing costs and fees, so be aware you will end up paying for the fees somehow. The following are three types of commonly offered no cost mortgages.

1. No Points Mortgage

In this type of no cost mortgage, you won’t pay points, but you’ll still pay the lender fees and charges for third party involvement.

2. No Points No Fees Mortgage

In this type of no cost mortgage the lender will waive lender fees, but you’ll still pay third party fees (appraisal, title transfer, etc). The lender will probably charge you a higher interest rate in order to recover the money they lost when they waived the fees.

3. Rolled Fees No Cost Mortgage

In this kind of no cost mortgage, the fees and costs are rolled into the mortgage (increasing the size of your loan) and are paid by you later, as part of the loan repayment plan. A better name for this option would be a “delayed cost” mortgage, since you will still pay the closing costs. In fact, you’ll probably end up paying more in the long run because most no cost mortgage lenders charge higher interest rates to compensate for absorbing the costs upfront.

When is it a Good Idea to Use a No Cost Mortgage?

If you can’t pay the closing costs upfront but need to refinance, a no cost mortgage option can be a good idea as it can allow you to stay in your home or buy a home even if you don’t have the money to cover the closing costs. Just make sure you have the long-term financial health to handle the extra cost in the long run.

If you are in a bad credit situation or are upside with your mortgage (meaning you home appraises for less than you owe on your mortgage) and you need to refinance in order to lower your monthly mortgage payments, you may qualify for a no cost or low cost, low interest refinance through Obama’s Making Home Affordable program. These options are excellent for those in financial trouble because the interest rates are lower than those offered in traditional no cost mortgages.

It’s best to use a no cost mortgage if you plan on selling in less than five years, before the higher interest rates or rolled fees will cost you more than what you saved by using the no cost option. Identify the break-even point to determine if this is a good option for you.

When is it a Bad Idea to Use a No Cost Mortgage?

If you plan on being in the home for more than five years you probably don’t want to use the no cost option unless absolutely necessary. This is because once you cross that break-even point, you’ll be spending money you could have saved if you’d paid the fees upfront.

No Cost Mortgage Conclusions

In general, no cost mortgages are best for those who need to refinance to lower monthly payments but cannot afford to pay closing costs.  If your goal is to save money overall, a no cost mortgage is not usually a good idea (unless you plan on selling every couple years going from one no cost mortgage to another and always selling before the cost of the interest or rolled on interest will catch up with you.) If you have enough cash available upfront that you can look into other options, you probably should consider other options before signing.