This post will cover why we’ve refinanced so many times, how we paid $0 for the first two through a no cost refinance, and how much we expect to save with our latest.
Refinancing your mortgage (the traditional viewpoint)
How often is too often to refinance your mortgage? Well, since we just finished our third refinance in two years, I’m guessing pretty darn often. While most lenders have a 6-month “seasoning” period, the more important factor to this question becomes whether or not the costs to refinance make the savings worth it.
The traditional rule of thumb is that you should consider a refinance when rates fall 0.5% to 1% below your current rate. Whether or not the cost will be worth it, depends on how long you plan to stay in the home or carry the mortgage. The breakeven point is the day cumulative savings from the lower rate exceed the costs paid for the refinance.
An alternative viewpoint is to consider if you could obtain a better rate (no matter how small) for no additional cost. If so, there would be no break-even period or sunk costs to consider. A “no cost” refinance can achieve this, and it’s precisely the reason we were comfortable refinancing our mortgage three times over the past two years.
What is a no cost refinance?
I know what you might be thinking… these dummies have been swindled. I assure you, we have not.
When most people first hear the term “no cost refinance,” they assume it’s a marketing trick and look for the hidden costs. We thought this as well. However, we’ve since embraced the concept as we’ve seen firsthand the benefits it can offer under the right circumstances. It’s okay to be skeptical, there is a cost to everything (including this).
To clarify, a no cost refinance is NOT a mortgage that has had closing costs financed into the loan amount. While this reduces the cash you pay at closing, it is NOT no cost. Those costs are included in the loan and you will pay them in the future, with interest. I don’t recommend this.
A no cost refinance is one in which the lender credits paid to you at closing fully offset the closing costs charged.
How do you get lender credits this high? By accepting a higher interest rate. Just like you can buy a lower interest rate with “points,” the lender is willing to pay you “points” to accept a higher interest rate. So, for those of you looking for the hidden cost, there it is. The higher interest rate is the cost.
However, if you’re able to get a lower rate using this approach, isn’t it a win-win? If rates have dropped low enough that there’s a rate with enough lender fees to cover the costs, then there’s little reason not to refinance. You’re basically getting a better rate for nothing.
While this strategy may provide the clear sign to refinance, you’ll still want to consider if your circumstances support paying more for a better rate. We’ll discuss that later.
Our experience with a no cost refinance
As mentioned above, we’ve refinanced the mortgage on our current home three times since moving here two years ago. The first two of these were no cost refinances, since the closing costs were less than the lender credits offered for the interest rates we selected.
Why would we accept a higher rate just for lower closing costs? Well, shortly before we moved to Arizona, we refinanced our North Carolina home. Thinking that it was our forever home, we paid $1,300 in points to get a better rate ($4,600 total closing costs). The breakeven period for all these costs? Somewhere around 7 years. We moved a year and a half later and lost out on most of those savings.
That’s why, when our mortgage broker suggested we consider a no cost refinance this time, we heard him out and ran the math.
Buying down an interest rate with points usually takes 6 – 8 years to break even. It you’re considering a refinance you can use Nerd Wallet’s calculator to determine your exact break-even period.
The same logic applies to negative points as well. Since most people don’t stay in their home that long anymore, it actually rarely makes sense to pay points.
We don’t plan on being in our home that long, and even if we do, we previously planned to aggressively pay off the mortgage before then.
Refinance #1
We bought our home in late 2018, and our first refinance was in April 2019. Rates fell significantly in that time period, so we were able to reduce our rate from 4.375% to a 3.375% (15-year mortgage).
While we could have obtained a better rate by paying more, we opted for the higher interest rate to make the refinance no cost. Our closing costs were $2,099, but we received lender credits of $2,287, for a net payment to us of $188. So basically, the lender paid us $188 to reduce our mortgage rate by 1%.
As stated above, there were no hidden costs financed into the loan amount. The only “cost” related to this was the potential opportunity cost of not paying more for a better rate. Given our plan to pay down the loan quickly, we decided the no cost option was better for us.
Refinance #2
Rates dropped again this spring, and since we hadn’t lost any money refinancing the mortgage the first time, we had no problem taking advantage of lower rates again in March 2020. Though the benefit wasn’t as impressive this time, we were still able to save another 0.25% on our interest rate and lower the monthly payment by $427 per month.
Again, the lender paid us $241 for this privilege.
Refinance #3 – Completed last week!
I was surprised when rates fell even lower after our March refinance, but they did. We pulled the trigger again in October 2020, after changing our debt paydown strategy (more on this decision and our analysis in a future post).
Closing costs for a $200,000 loan were quoted at $2,355. The table below summarizes our pricing options on the day we locked our rate. You always have a range of options when you refinance. We could reduce our rate by 0.375% for no cost, pay closing costs of $3,855 to save another 1.0% on our rate, or pick something in the middle.
| Interest Rate | Points/(Credits) | Monthly P&I | Net Cost to Refi |
| 2.125% | $1,500 | $1,299 | $3,855 |
| 2.250% | $250 | $1,310 | $2,605 |
| 2.500% | ($1,500) | $1,334 | $855 |
| 2.625% | ($2,000) | $1,345 | $355 |
| 2.750% | ($2,500) | $1,357 | ($145) |
Even though we’re fans of the no cost refinance, we opted for a slightly better “low cost” rate this time around. We did so for two reasons. First, this is the last time we intend to refinance this home, so we don’t want to be tempted by lower rates in the future. The second reason is related to our change in paydown strategy, as we no longer intend to make additional payments to pay the loan down faster. As such, we’re willing to pay a little extra for a lower rate.
Why not pick the best rate we could get? As pointed out above, the break-even for points is generally 6 – 8 years and we aren’t sure we’ll be in this home that long. A 2.5% interest rate is still 0.625% lower than our current rate and only had net closing costs of $855. We’ll recoup these costs in the first 9-months. Even if we do move before the break-even point, we have little to lose.
How much will this refinance save?
I’m not sure – somewhere between $400 and $39,000. Why? Because the savings depends on our actual pay down timeline and future stock market returns. Let’s dig into this further…
Here are the terms of the two loans that we’ll use to assess the cost savings. For the analysis below, I’ve assumed that we only pay the minimum P&I each month.
| Refinance | Original | Difference | |
| Date of Loan | Nov 2020 | Mar 2020 | |
| Loan Amount* | $200,000 | $249,100 | ($49,100) |
| Monthly Payment | $1,333.58 | $1,735.25 | ($401.67) |
| Interest Rate | 2.500% | 3.125% | (0.625%) |
| Expected Payoff Date | Dec 2035 | May 2032 | +43 months |
| Total Interest Paid | $40,899 | $38,116 | $2,783 |
| Net Closing Costs (incl. in interest) | $855 |
Interest savings
If you look closely, you’ll notice that the total interest paid under the refinanced loan is actually higher than the original loan. What?!
I know this seems strange at first glance, but once you review the amortization tables for both loans it makes sense. The original loan has larger payments, so even though the rate is higher, the total interest will be slightly lower than the new loan.
However, it’s important to note that monthly interest payments under the new loan won’t surpass those on the original loan until after February 2027, or over 7 years from now.
In month 1, we’ll save $104 in interest ($417 new loan vs $521 old loan). That monthly savings will slowly decrease each month as the loan is paid down until it crosses the break-even point in early 2027. The maximum total interest savings occurs in February 2027 at $4,034. After that point, the cumulative savings decreases, until it actually turns to a loss in March 2029.
If considered in isolation, the negative interest savings might lead you to believe the refinance is a bad idea. However, you’d be forgetting about the most important cost of large purchases …
Opportunity cost
I’ve written about opportunity cost before in our analysis as to whether or not to build a pool. It’s always an important consideration in making significant financial decisions, including this one.
The monthly mortgage payment on our new loan is $402 less than the old loan. That’s $4,820 per year we no longer have to put towards debt. Instead, we can invest this difference in the stock market each month and watch it grow over the next 15 years (or until we sell).
This is where the uncertainty arises as to how much money we’ll save with the refinance, since it depends on market growth, which I cannot predict. However, being the nerdy accountant I am, you know I ran several different paydown and market scenarios before making a decision.
Hypothetical investments made:
Refinance Portfolio: In this scenario, $401.67 is invested every month from Jan 2021 (first payment) to May 2032 (date original loan is paid off).
Original Portfolio: In this scenario, we invest $855 for closing costs at the refinance date, but no further investments are made until the loan is paid off in May 2032. After that, $1,333.58 (mortgage payment for refi loan) is invested every month until that loan is also paid off in December 2035.
On December 31, 2035, the balance on both loans will be $0, so we only need to compare the investment portfolios for each to determine how much better off we are. The amount of interest paid is actually irrelevant to the analysis.
The table below shows the results of different market simulations assuming that both loans are paid as slowly as possible.
Investment Portfolio once mortgage paid off (12/2035):
| Average Annual Market Return* |
Portfolio Balance – Refinance | Portfolio Balance – Original | Difference |
| 1.0% | 59,572 | 59,126 | 446 |
| 2.0% | 65,460 | 60,365 | 5,095 |
| 3.0% | 72,002 | 61,654 | 10,348 |
| 4.0% | 79,278 | 62,998 | 16,280 |
| 5.0% | 87,377 | 64,403 | 22,974 |
| 6.0% | 96,339 | 65,874 | 30,465 |
| 7.0% | 106,457 | 67,419 | 39,038 |
I’m fairly pessimistic when it comes to market returns; however, I believe this is a pretty reasonable range for the next 15-years. Obviously, our actual savings will depend on real returns and mortgage to term, but this analysis provides a ballpark.
My personal projections use returns between 4% and 5%, which would result in savings of around $20,000 over the next 15 years if we hold the loan to term. If we sell in 7 years, we’d still be ahead by around $7,000. Not bad for $855 in closing costs.
On the fence as to whether or not to refinance? Here are some things to consider:
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- How long do you intend to stay in your home?
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- Will you pay off the mortgage early?
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- How much lower is the interest rate you could get by refinancing?
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- What are the closing costs and can you cash flow them?
If you’re on the fence, I would encourage you to look at the best interest rate you could receive in a no cost scenario. Most online lenders publish rate sheets and can provide you an estimate of closing costs with no commitment or formal application. If you can reduce your rate by 0.25% or more for net $0 closing costs, then it might be worth the effort.
Your answer to the above questions can then help you determine if paying the closing costs to get an even better rate is worth it.
If you plan to pay your loan off quickly or move in the next few years, then a no cost refinance may be your best option. This is why we chose it. However, if you’re in your dream home and plan to pay the loan slowly, it might be worth it to pay for a lower rate.
This is all (of course) my personal opinion and you should do your own research. I promise, it’s not too difficult to set up amortization tables for a quick analysis in excel.
