Closing Costs. Zero Closing Costs. No Out of Pocket Costs, No Points. We hear a lot about this stuff but when it comes time to refinance, do we really know what closing costs we are paying? The truth of the matter is that mortgage companies know you're fixated on closing costs. Because it's next to impossible to make an apples to apples comparison of closing costs between competing lenders, even with Good Faith Estimates, unscrupulous marketers are frequently able to get you to take your eye off the ball by promising unrealistic closing costs, while smoothly throwing a fastball and couple of sliders right past you for a strikeout. So how do we avoid being hit by the pitch? We need to evaluate the costs as they amortize into the loan, one way or another.

First, I'd like to debunk the notion of "No Closing Costs", heavily advertised by national marketers and banks. Have you ever heard the expression "There's no such thing as a Free Lunch?". All things in this world have costs to produce, and if you know anything about the companies that produce things, you'll agree that they do their darndest to make you pay for them.

Here is a list of things which are the bare minimum costs of refinancing a loan:

Title Search & Title Insurance: An inescapable fact of life, these are the costs charged by a third party company whose job it is to find out whose names are recorded in relation to the property, establish a chain of title going back 24 to 60 months, to uncover any judgments, liens, zoning issues, etc. That's the title search. Title work will also include name searches and "plat drawing". Then, based on a variety of factors, including the level of risk that they perceive from the title search and the value of the property, they underwrite Title Insurance which covers the lender in case they did not find someone or something on title which make the loan uncollectible. Like taxes, there's no way to escape this fee, however you may be able to minimize it if you can use the same company you used when you bought the house or last refinanced (look at the closing documents)

Title Search averages $300 nationally, with some markets coming in lower and some much higher

Title Insurance is Variable because there are so many factors in involved including the property's value, but the national average is about $700, although it's not unheard of for title insurance to cost as much as $3000 or more depending on the size and complexity of the property and the chain of title.

Settlement, the actual coordination of the loan closing, is often listed as an Attorney fee or Escrow Fee. This is necessary to ensure that all the paperwork is correct and that everyone who needs to get a check at closing, be it you, a service provider, your old lender, or any number of creditors you may be paying off. The average is $500, and varies again with the market.

Other title expenses may or may not be required at the discretion of the lender or title company to ensure the security of the property, including surveys, bankruptcy searches, etc. These fees again vary but you can expect your title bill to be the largest third party fees in connection with a loan.

Government Fees: Another one you can't get around is the government's fees which can be broken down into Taxes and Recording Fees, but can include more.

City/County/State Tax Stamps and Intangible or Mortgage Taxes vary so dramatically that I cannot even begin to address this issue here, but range from nothing at all to 3% or more of the property value. This is NOT the same thing as property tax.

Recording fees are the costs your county recorders office charges to file your deed, is mandatory, and range from $75 to $250 dollars.

Other Third Party Fees:

Appraisal: National Average of $350 but can be much higher depending on property size and location.

Credit Report: Averages $30

Flood / Pest / Other Inspections: Averages $100

Basic Lender Costs:

(remember, there are significant regional variations for these fees, and bigger homes carry bigger fees)

Tax Service: $75 Average

Wire Transfer: $35 Average

Processing: $400 Average

Lender Discount Points:

These are the "Points" on a loan, used to lower the interest rate to help you qualify for the loan based on your income. 1 point is 1% of the loan amount, so one a $200,000 loan a point is $2,000. You usually don't need to pay points if your debt to income ratio or DTI, the measure of all of your debt payments plus your monthly housing expenses under the new loan, are below 40%. DTI guidelines are much more stringent today than they were even 3 months ago, especially for borrowers who are stating their income to qualify for the refinance.

Fees & Profit:

Up until now, everything we have discussed has been around the hard costs of the loan. Now we get into the fee for service, where the lender or broker actually tries to make money, not unlike any other service provider such as an investment advisor, realtor or lawyer:

Origination Fees: Often charged as a percentage of the loan

Broker/Lender Fees: Again often charged as a Percentage of the loan

It's important to remember that no one can do a loan for free, no matter how good of a customer you are, because each loan is a profit or loss to the lender by itself, and they have to assume that at one point or another the loan must be sold. Their time and their risk are valuable, just as your own or your lawyer's or your realtor's.

Closing costs vary not only by location, but depend heavily on what you qualify for, so your credit will affect the final numbers, especially with regard to Discount Points. Calculating your own closing costs can be best achieved by speaking with a mortgage company who can give you a Good Faith Estimate which outlines all of the above mentioned fees.

Different Ways We Wind Up Paying For Closing Costs

Now that you've seen everything laid out, do you believe anyone can offer a "No Closing Costs" refinance? These hard costs are always paid for one of two ways:

You are billed for each item and can choose to pay them in cash at closing or to roll the costs into the new refinance so that there is no money out of pocket to you.

You are charged a higher rate than you would normally qualify for over the life of the loan, which allows the lender to realize a premium, or a profit, which they can then credit toward your closing costs. So if the best rate you qualify for, with no discounts, is 6.00%, raising the rate slightly, to 6.375% or 6.625%, may provide you with a "rebate" which the lender can choose to apply to closing costs. Sometimes these methods are used in combination. My recommendation is to compare the payments. Let's look at two completely hypothetical examples:

Example 1: Roll Your Costs into the Loan Balance

$400,000 Refinance Loan Amount

$8,000 in Closing Costs

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$408,000 Financed

At 6.000% Interest over 30 Years

Has a Monthly Payment of $2446 for Principal & Interest

And a Monthly Payment of $2040 for Interest Only

A Typical Minimum Payment Option Would be About $1500

Example 2: Use a Higher Rate to Finance Closing Costs

$400,000 Refinance Loan Amount

"$0" in Closing Costs (assuming the $8,000 in hard costs is advertised as Zero)

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$400,000 Financed

At 6.625% Interest over 30 Years

Has a Monthly Payment of $2561 for Principal & Interest

And a Monthly Payment of $2208 for Interest Only

A Typical Minimum Payment Option Would be About $1465

The reason I've included Interest Only payment option figures above is to show you how much more interest you pay each month if you choose a "Zero Closing Costs" option from any leading lender, versus rolling those costs into the loan. The final option is to pay for these costs out of pocket, which is not a very popular option today, but deserves treatment.

Example 3: Pay your own closing costs

$400,000 Refinance Loan Amount

$8,000 in Closing Costs Paid out of Pocket

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$400,000 Financed

At 6.000% Interest over 30 Years

Has a Monthly Payment of $2400 for Principal & Interest

And a Monthly Payment of $2000 for Interest Only

A Typical Minimum Payment Option Would be About $1465

Compared to rolling the closing costs into your loan, paying them out of pocket saves 46 dollars per month of principal and interest or 40 dollars of interest, a savings of about $500 a year or less. So unless you can't get a return of more than $500 per year on your $8,000 investment (about 6.25%), there's no strong argument to pay for the closing costs out of pocket. Online savings accounts and CDs already offer rates equivalent to this, and the S&P 500 has been returning about double this rate, so I personally would rather have access to my money and have it working for me. I won't get into the fact that the extra $500 or so dollars of mortgage interest per year should be tax deductible as well (and please consult your CPA, we don't give tax advice).

Cost - Benefit Analysis

Finally, we can turn to the benefits of refinancing and weigh them against the costs. We are going to do this by taking a before and after hypothetical situation, with the closing costs rolled in.

Hypothetically, let's say that you want to refinance to Lower Your Monthly Payment, Change Your Loan Terms to get a fixed rate, and Take Advantage of the Equity Growth in Your Home to pay off your personal loans and credit card bills, and to improve your home to increase your quality of life. You are not planning to retire in this home, and plan on selling it in 5 years, but like the idea of a secure, fixed rate just in case rates go up a lot over the next 5 years. With the way the economy is going, you also want to keep your mortgage payment as low as possible, so in case anything happens you have the option to pay less on your mortgage.

You have a current mortgage balance of $350,000 dollars on which you pay $2250 per month, and your home is worth $600,000 dollars today compared to the $425,000 it was worth when you bought it.

You have about $32,000 in debts, on which you pay minimum payments of about $1500 a month and would like to take an additional $18,000 to do the kitchen, which you believe would improve the value of your home by $30,000.

So your total monthly spending on mortgage + cards etc. is $3750

Let's say your credit score is 620, very average for a person with your level of credit card and other unsecured debt, and you prefer to state your income.

Hypothetically (this is only meant to be illustrative), you receive a rate quote and Good Faith Estimate which outlines the following:

Quote 1: Conventional 30 Year Fixed

$400,000 Refinance Loan Amount

$8,000 in Closing Costs

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$408,000 Financed

At 7.250% Interest over 30 Years

Has a Monthly Payment of $2783 for Principal & Interest
A Savings of $967.00 a month

Quote 2: Interest Only 30 Year Fixed

$400,000 Refinance Loan Amount

$8,000 in Closing Costs

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$408,000 Financed

At 7.500% Interest over 30 Years

Has a Monthly Payment of $2550 for Interest Only
A Savings of $1200.00 a month

It seems like a no-brainer right? The interest only is much lower, however your basic housing expense has still gone up $300, even though you've paid off all the cards and saved almost 1200 there. With the credit cards, even if you experienced a loss of income due to circumstances outside of your control, at least you could have afforded to miss those payments and scratch together money to make your mortgage payment, because the credit card lates would not cause you to lose your house. But with this refinance, which meets most of your goals, now you have to come up with a larger mortgage payment. So you get one more quote for a mortgage which allows for deferred interest, or making a minimum payment when you want to:

Quote 3: 30 Year Fixed Rate Cash Flow option mortgage

$400,000 Refinance Loan Amount

$8,000 in Closing Costs

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$408,000 Financed

At 7.500% Interest over 30 Years

Has a Monthly Payment of $2550 for Interest Only

Has a Minimum Payment Option of $1497

A Savings of $1200.00 a month on Interest Only
Ability to Defer Interest and Reduce your current minimum payment by over $2250.00

This is a fixed rate loan with the ability to defer interest, or a negative amortization loan, which allows you to use your remaining equity like a home equity line of credit whenever you want, with no closing costs. When you want to make a lower payment so your monthly cash flow goes further, you can do so by making the minimum payment, which borrows from your home equity to cover the difference between the interest only payment and the minimum payment. While the adjustable rate version of these loans are too risky to achieve your particular goals, a truly fixed rate cash flow option might be the answer, fulfilling all of your reasons to refinance while giving you security and flexibility for when a lower payment might be helpful.

Conclusion:
All loans costs money to originate and refinance, even if it's not always clear how you may be paying for them. As we have seen, if you aren't taking out a fixed rate cash flow option mortgage with the intent of only paying the minimum payment, most of the time it's better to roll your closing costs into your loan, so that there is no out of pocket expense to you. Always remember to see if the loan achieves your goals, and don't put too much stock in the GFE's you receive while shopping around, because people, whether broker or bank, are more than willing to lie to you to beat out their competition initially, so they can lock you into a process which you cannot easily reverse. My recommendation is to speak with as many people as you can, but evaluate them on the basis of trust. You may find that the person who gives you the highest quote may be the only one telling you the truth. This is not a simple subject to discuss, and while we have tried to treat the subject thoroughly, a consultation with a refinancing specialist would be the best way to get answers specific to your situation.