The no cost refinance also called a no fee refinance idea is promulgated via advertisement by many mortgage companies across the country. This no closing cost refinance fantasy will be put to rest here and now.

I estimate half of the people I have discussed mortgage refinancing with over the last year have wanted to know more about the so-called no closing cost refinance. They admitted they saw on TV or heard on the radio advertisements promoting refinance programs with no closing costs.

Note: Read Our Top Five Mortgage Complaints!

No Cost Refinance Loans Examined

Many lenders, banks, and brokers, at one time or another, became advertisers of “no cost” refinances. Let me clear this up once and for all…I prey you understand the following points.

There are only 3 ways mortgage closing costs or fees get paid on a refinance:

1. Borrower Pays by bringing a check to the closing. (not very popular)

2. Borrower Pays by using yield spread premium to pay them. Taking a higher rate creates money to pay costs. The typical no cost refinance method uses this means to intimate their loan is free of costs.

Since when does paying a higher monthly payment for the length of the loan translate into “no cost”?

Paying the costs with a higher rate/monthly payment could add thousands of dollars over the one-time closing costs to the “Total Cost” of the loan if you held this load to the end of the term. Only in the marketing minds of banks and brokers would this ring true.

3. Borrower Pays by rolling them into your loan. In other words, financing the costs into the new loan.

For example, if the current mortgage payoff is $200,000 and your closing costs are $5,000, your new loan amount when you refinance is $205,000.

I want you to notice something about all 3 of the closing cost payment methods above:

You Pay Regardless of the Method!

Now remember, there are always costs or fees for a refinance and YOU always pay one way or the other!

It is a new loan….no one can do a refinance for free.

Translation: The no cost refinance rate is higher than current mortgage rates with costs built in. That higher rate produces money used to pay the costs of the refinance and then line their pockets with who knows how much. They pay your costs with a small portion of the money created with YSP then take the rest for themselves.

Also, don't be one of those people who will step over a nickel to pick up a penny.

We have been trained in this country to think closing costs are bad. Remember, closing costs are in every refinance. There is no getting around it. All you have to do is determine which of the three ways is best for you and your circumstances.

How To Pay Your Closing Costs

Let's examine all three ways (what I'll call the Pay'm Now, Pay'm Via Rate Bump, and Pay'm Via Bigger Loan) to pay your costs and use a few examples of when each one might be appropriate.

First, the Pay'm Now method is the cheapest since you are simply writing a check. Cash is King and here is no exception.

Paying one-time closing costs with your own cash won't incur any costs other than the “opportunity cost” of doing something else with the money like putting it in a savings account earning 1.3%. Some folks will tell you this is a real cost, but for most Americans who can't find better investments than a savings account…it really isn't. The problem with this method is most Americans don't have $1,000's of dollars saved for this occasion.

Second, the Pay'm Via Rate Bump, is a viable option in the narrow circumstance of knowing you'll be moving soon…within 1-3 years… so you are not stuck with the higher rate for very long. Once again, for most Americans this is not a viable option since they don't move that frequently. Some home owners can't move that often due economic conditions (like being underwater on their house) even if they wanted to.

Third, the Pay'm with a Bigger Loan, is the most viable option for the majority of Americans. This method doesn't come with a rate bump, but a loan balance bump. If you need $200,000 and closing costs are $5000, the you simply increase the loan amount and borrow $205,000. That increase of $5000 effects the monthly payment minimally and you have an opportunity to get the $5,000 back with a little trick I'll describe now.

Trick To Recouping Your Closing Costs

I'm going to show you how you reduce the principal by more the $5000 you increased it to cover the closing costs. In other words I'm going to show you how to get your $5000 back.

Here goes.

With each payment on this example mortgage…a $205,000, 30 year, fixed rate at 6% with PI payments of $1229.08 on an amortization schedule is broken into 2 parts…the interest and the principal. How you pay in the first few months can recoup the $5,000 in short order?

Prepayment of principal is allowed on virtually every loan, so this will work for every one. The principle behind prepaying your mortgage is that the bank cannot charge you interest on any principal monies you paid before they were due, hence the name “prepayment of principal”.

So how to you recoup $5000 on this $205,000 loan?

You must make a full payment every month (a provision in your mortgage note) accompanied by the next month principal. This method with save you the next months interest. Do this for about 5 months and you've reduced your principal balance by about the same amount you increased it to cover your $5,000 in closing costs….you are back to even!

Let's use the amortization schedule below to see just how this works in the real world. You write a check for first full payment for $1229.08 as normal. Then you look at the second payment line to locate the Principal amount ($205.10) then write another check for that amount putting in the memo “Prepayment of Principal for Oct. 2010″. Include both checks in the same envelope and mail them to the lender.

What have we done here…Well we saved the $1,023.98 in interest associated with payment 2 of this loan by prepaying payment 2's $205.10 principal a month early.

Next month comes and we do this again, but this time we drop down to payment 3 to make our a full payment check, then look at payment 4's principal amount for the prepayment check. Once again the first check is $1229.08 and second check is $207.16. This second month of full payment plus the following months principal saved $1021.92.

We follow this pattern for 5 months and we save the sum of the interest for payments 2, 4, 6, 8, and 10. Add that up and we've saved $5098.25. We've got more than our closing costs back! Sure we have to spend about an extra $200 each month to get there, but that's a small price to pay.

Month / Yr Payment Principal Interest Total Interest Balance
1. Sept. 2010 $1,229.08 $204.08 $1,025.00 $1,025.00 $204,795.92
2. Oct. 2010 $1,229.08 $205.10 $1,023.98 $2,048.98 $204,590.82
3. Nov. 2010 $1,229.08 $206.12 $1,022.95 $3,071.93 $204,384.70
4. Dec. 2010 $1,229.08 $207.16 $1,021.92 $4,093.86 $204,177.54
5. Jan. 2011 $1,229.08 $208.19 $1,020.89 $5,114.74 $203,969.35
6. Feb. 2011 $1,229.08 $209.23 $1,019.85 $6,134.59 $203,760.12
7. Mar. 2011 $1,229.08 $210.28 $1,018.80 $7,153.39 $203,549.84
8. April 2011 $1,229.08 $211.33 $1,017.75 $8,171.14 $203,338.51
9. May 2011 $1,229.08 $212.39 $1,016.69 $9,187.83 $203,126.13
10.June 2011 $1,229.08 $213.45 $1,015.63 $10,203.46 $202,912.68

As you can see interest is front loaded on a new loan, so you get more bang for the prepayment bucks if you do this from the very start of the new loan.

You could also on the very first payment simply make a full payment then drop down to line 2, 3, 4, 5, 6 locate each payments Principal and write 5 additional prepayment checks for each month and send them in all at once… if you had the money.

It's tough to come up with just over $1000 all at once, but anyone can find the $200 a month with the slower version.

Now of course, you could just keep going and save even more…but that is up to you. I just wanted to show you how a savvy borrower could roll their costs into the loan…and get them back in 5 short months.

Good Luck!

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