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I'm refinancing a mortgage of ~$800k. This is our only/primary house and we do not haven any intent to move in the forceable future.

There are multiple parameters/choices and they make my head hurt.

One choice is how many points to buy.

Another choice is whether to do a no-cost refinance. (And it looks like the no-cost option is adding some costs to the points).

Rate APR Payment Points Additional closing costs Total closing costs
2.875% 2.891% $3338 -$6,035 ~$10,795 $4,760~=~$10,795-$6,035
2.750% 2.765% $3285 -$3,017 ~$10,795 $7,778~=~$10,795-$7,778
2.625% 2.649% $3232 $1,006 ~$10,795 $11,801~=~$10,795+$1,006
2.490% 2.542% $3175 $4,023 ~$10,795 $14,818~=~$10,795+$4,023
2.375% 2.455% $3,127 $7,040 $10,795 $17,835
No-cost: - ~$900-$1200 more - -
2.875% 2.890% $3419 -$5,151 -$486~
2.750% 2.765% $3365 -$2,060 -$486~
2.625% 2.659% $3310 $2,060 -$486~
2.490% 2.552% $3252 $5,151 -$486~
2.375% 2.465% $3203 $8,241 -$19,056 -$486 (they pay me)

Since we're currently at the historical rate minimum I think that it makes sense to lock in the lowest rates I can get. So, I plan to get 2.375% (0.8 points = $7040). It seems that the naïve break-even period will be around 5 years compared to the higher rate of 2.490%.

But then I looked at the full closing costs and thought about making this a no-cost refinance. The money that I can spend on closing costs can be invested at higher percent than the 2.375% mortgage so it makes sense to me to not pay a lot of cash outright. Only two things bother me here: The loan becomes significantly bigger (+$19,056) and the points are now ~$1000 costlier.

The monthly payment with no-cost 2.375% will be $3203 - $76 more compared to $3127 I'd get if I paid the closing costs. So, I'm exchanging paying $17835 right now for paying $76 for 360 months totaling $27360. Seems OK...

Am I making a mistake by going with the lowest rate I can get and making the refinance no-cost?

One scenario I see where my choice would be wrong is if the mortgage rates go down significantly. But it does not seem likely to me.

P.S. A third option is to either put only ~half of the closing costs on the loan, since another half is just the prepaid interest, taxes etc, that I'll just get from the old escrow. The fourth option is to take more cash out of the mortgage and invest it. The fifth option if to pay-off ~$30,000 and make the mortgage non-jumbo, expanding my loan options. But I do not like this option, since I'll be immediately parking lots of cash in the house. Maybe in December the jumbo limits will be raised.

All options I have in mind:

  1. Pay closing costs with cash ($17835), reducing my reserves. Monthly payment: $3127
  2. Put the cost of points and the fees on the loan (+~$10795), keeping my reserves at the same level. Monthly payment: $3127
  3. Put the cost of points and the fees on the loan (+$19,056). Monthly payment: $3203
  4. Cash-out money from the loan. Monthly payment: $3203
  5. Pay-off ~$30,000 to make the mortgage non-jumbo and get new rates.
  6. Wait until December and pray that the jumbo limits are raised and the rates are still low.

P.P.S. I really do not understand the formula that the banks use to price the points. It seems to be really weird that I have a choice of 8+ different no-cost loans and they all have different rates and monthly payments.

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There are no no-cost refinances. Somebody has to pay the cost of the paperwork, filing fees and the reappraisal. That somebody is always the borrower. You either pay at the closing table by writing a check for those things or a higher mortgage amount.

The same thing happens with the buying down the interest rate. To lower the monthly rate you have to pay more at the closing table.

These options appeal to some borrowers because you don't have to write a big check at closing. Though each month you make a payment that is a little bigger. As you have calculated it can take years to break even.

You have to do the math and see which option works for you.

I then saw this option mentioned:

The fourth option is to take more cash out of the mortgage and invest it.

That means this is a cash out re-finance. That brings in some tax questions.

I am going to assume this is the United States, though you haven't mentioned the country. The new mortgage will be for more than what was needed to acquire the house. So some of the interest you pay will not be tax deductible. Make sure you have also factored that into your analysis.

I also wonder does it make sense to get cash out and make it a no closing cost mortgage. In the end you are deciding do I get a check from closing for X or for Y. In some of the options you mention keeping your reserves the same but in a cash out refinance your reserves are never touched.

Regarding cash out finances:

This is from IRS Publication 936 (2020), Home Mortgage Interest Deduction

To be fully deducible:

Mortgages you (or your spouse if married filing a joint return) took out after December 15, 2017, to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2020 these mortgages plus any grandfathered debt totaled $750,000 or less ($375,000 or less if married filing separately).

Since the mortgage isn't to buy, build or substantially improve the house then this part applies:

Refinanced home acquisition debt.

Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home isn't home acquisition debt.

That means if the old mortgage was for $600,000 and the new mortgage is for $600,000 the additional $200,000 in debt isn't deductible. To make more of it it deductible you would have to spend the money on an upgraded kitchen, bathroom, or an addition. The publication discusses the rules associated with this in more detail.

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  • "There are no no-cost refinances." - I've described how this works and included the relevant math. The closing costs are rolled into the new loan amount. So the loan is bigger and I pay more each month, but I do not pay a big lump sum in the beginning. It's similar to HELOC or the mortgage itself - take a loan to spread payments over time.
    – Ark-kun
    Sep 6 at 8:37
  • "The new mortgage will be for more than what was needed to acquire the house. Some of the interest you pay will not be tax deductible" - Hmm. I was not aware of this. This sounds a bit strange. When buying the house, I borrowed 80% of the house value. (I could borrow less, but decided on this maximum amount.) Over the years the proportion has changed the loan amount is less than 80% of the house value. If I do cash-out refinance where I restore the loan value [up] to 80% of the house, I do not see why it would be different from the normal mortgage.
    – Ark-kun
    Sep 6 at 8:43
  • If you roll the cost into the mortgage, then you are still paying the closing costs. In fact you are borrowing the closing costs at 2 or 3% for 30 years. Sep 6 at 12:01
  • "you are borrowing the closing costs at 2 or 3% for 30 year": Yes, I understand this: "The loan becomes significantly bigger (+$19,056). The monthly payment with no-cost 2.375% will be $3203 - $76 more compared to $3127 I'd get if I paid the closing costs. So, I'm exchanging paying $17835 right now for paying $76 for 360 months totaling $27360. Seems OK..."
    – Ark-kun
    Sep 6 at 21:57
  • Thanks for the "Home Mortgage Interest Deduction" link and quote. I'm still reading the doc, but it looks like it does not change anything for me, because my loan is already too big. Only the interest on the first $750k of the loan is deductible, but my loan is >$800k. So whether I decrease the loan (say to $770k) or increase the loan to (say to $830k), the interest I can deduct will remain about the same (~=0.0237 * $750k).
    – Ark-kun
    Sep 6 at 22:03
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The APR is supposed to give you the overall "cost of borrowing" taking points and closing costs into account. So in principle the loan with the lowest APR would be the "cheapest" loan (compared to borrowing less).

With a "no-cost" closing, you're effectively borrowing the closing costs be either increasing the loan amount or increasing the interest rate.

That assumes, of course, that you have the cash on hand to pay all of the closing costs, and don't have other higher-interest-rate debt that the money could go to. It makes no sense, for example, to spend $10k to reduce your mortgage by 10 basis points when you have a 6% car loan or 18% credit card debt that you could pay off instead (unless those debts will be cleared in a very short time).

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  • With no-cost closing, the loan amount increases (so monthly payments slightly increase as well), but this also frees up cash that can be used to invest or pay other loans, which seems to me like a pretty rational choice.
    – Ark-kun
    Sep 9 at 5:35
  • Right, so you're "borrowing" the closing costs and paying them off over 30 years. I'm generally against borrowing just to invest, and typically paying off debt means borrowing for 30 years to pay off a loan that otherwise would be paid off in a few years. Since those are not simple to compare (interest rate is just one factor - you have to also consider length of time and risk) there's not a clear cut answer.
    – D Stanley
    Sep 9 at 13:10

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