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Amid high mortgage interest rates, some lenders are offering "buy now, refinance for free later" mortgages to incentivize homebuyers to borrow. While these offers are appealing to people who don't want to be locked into a high interest rate once interest rates go down, there are some limitations to consider.
Before you take out this type of mortgage loan to buy a house, here's what you should keep in mind.
How Buy Now, Refinance for Free Later Mortgages Work
High mortgage rates have significantly decreased demand among homebuyers who may not be able to afford—or don't want to pay—a high monthly payment for an extended period of time.
Many mortgage industry observers expect rates to decline in the near future, however. Refinancing can help homeowners reduce their monthly payment once rates decline, but the closing costs on a refinance loan can be expensive.
With a buy now, refinance for free later program, homebuyers can refinance when they're ready and avoid closing cost fees. Mortgage lenders began offering them as a way to increase loan originations at a time when they're down.
What Are the Limits of Free Refinances?
A free mortgage refinance could save you thousands of dollars, but these programs often have limitations that could impact your ability to qualify or take advantage of the benefits. While terms can vary by lender, here are some restrictions to watch out for:
- The lender may only waive lender fees, while third-party fees (appraisal, for example) still apply.
- The savings may be capped at a set dollar amount.
- You may have fewer than three years to refinance your loan, regardless of what interest rates look like.
Before you choose a lender that offers buy now, refinance for free later mortgages, review the fine print of the program to determine how much value you'll actually get.
How Much Does It Cost to Refinance a Mortgage?
Closing costs on a mortgage refinance typically range from 2% to 6% of the loan amount. On a $500,000 loan, for instance, your fees can range from $10,000 to $30,000. With a true buy now, refinance for free later program, you could avoid all of those costs.
But remember, some lenders may limit the free aspect of the refinance to lender fees, and you'll still need to pay for an appraisal, title-related costs and other third-party fees. And in some cases, your savings may be capped at an amount as low as $1,500, which would leave you to still deal with a major expense.
Pros and Cons of Buy Now, Refinance for Free Later
If you're thinking about buying a house in spite of high interest rates, here are some advantages and disadvantages to consider if a lender offers you a buy now, refinance for free later mortgage.
- You could save some money in the long run. If you're expecting to refinance once rates go down anyway, one of these programs can help you avoid at least some of the costs associated with that process.
- It can take the psychological edge off of high rates. You may feel better about taking on a high-rate mortgage loan knowing that you can easily refinance for less once you're ready.
- You'll still have a high monthly payment before you refinance. Consider one of these programs only if you can comfortably afford the initial monthly payment on the new mortgage loan. It's impossible to predict when and how interest rates will fluctuate, so you may be stuck with a high monthly payment for a while.
- It's not a guarantee. If interest rates don't go down significantly before your refinance option expires, you may not save much in terms of monthly payments. Ultimately, you may end up refinancing again at a later date if interest rates go down again.
- Your upfront savings may be limited. Depending on the program, you may still be on the hook for a lot of the closing costs on your refinance loan.
Alternatives to a Free Refinance
If you're considering a mortgage loan that offers a free or discounted refinance at a later time, consider all of your options before you proceed. Here are just a few:
- No-closing-cost refinance: These loans come with no upfront costs, but that doesn't mean it's free to refinance. Instead, you'll typically agree to a slightly higher interest rate or have the closing costs rolled into your loan to avoid the out-of-pocket expense.
- Adjustable-rate mortgage: Adjustable-rate mortgages (ARMs) offer a fixed rate for a set period of time—typically three to 10 years—that's lower than the interest rate on a traditional fixed-rate loan. While you'll need to pay for your refinance at a later date—preferably before the fixed rate turns into a variable one—you can enjoy a lower monthly payment now.
- Traditional refinance: If you can find a mortgage loan with a lower interest rate that doesn't come with a buy now, refinance later option, it may be worth it to take the lower rate now and then refinance traditionally when you're ready.
The Bottom Line
Buy now, refinance later programs can be a good incentive if you're planning to buy a home while rates are high, but it's important to consider all of your options before you decide on a lender. Consider the program's rules and limitations and compare the lender's interest rates and other terms with other potential loan options to determine the best fit for you.
Also, keep in mind that while these programs can help you save money, you can maximize your savings by building your credit before applying for a mortgage loan. Check your credit score and review your credit report to get an idea of your credit health and pinpoint which areas you can improve before you start the mortgage process.