There are many reasons to refinance a mortgage. Maybe you want to lock in a lower interest rate than your current rate. Perhaps you are looking to reduce the term of your mortgage. You might be interested in accessing the equity in your home to pay down existing debt, fund some home improvement projects, or finance a major purchase. However, before you can jump into this major financial decision, you must factor in all the costs associated with refinancing. This includes the closing costs, which can sometimes prevent homeowners with little cash savings from refinancing their mortgages.

What Is Included in Closing Costs?

Just as in the initial purchase of your home, a refinance of your mortgage includes a variety of costs due to the lender:

• The origination fee covers the costs of preparing the loan. Generally, the origination fee equals 0.5-1% of the total loan.

• Title fees include the cost of a title search and title insurance. You can expect a discount on this fee if you use the original title insurance company.

• FHA loans include a mortgage insurance premium that equals 1.75% of the loan principal. Conventional loans give the option to pay on the mortgage insurance policy at closing.

• An appraisal fee can run an average of $300-$500, depending on the size of the house and other factors.

• Credit report fees cover your credit check and are generally only $25-$50, dependent on your area and lender.

• Prepaid interest is generally a small figure as well, covering the interest that accrues between your closing day and your first payment.

• Discount points are an optional cost that exchange an upfront payment for a lower interest rate.

What Is a No-Closing-Cost Refi?

Homeowners often underestimate what they will have to pay in refinance charges when they plan to refinance their mortgage. Refinancing costs usually equal 3-6% of the loan's principal, which is generally paid in the form of closing costs.

A no closing cost refi is a good alternative for those who may not have the funds to lay out for traditional closing costs. While this option relieves the burden of upfront costs, it does not actually eliminate the fee.

Rolled-Up Principal

The most basic and popular type of no-closing-cost refi rolls the estimated closing costs into the principal and then divides it into monthly payments. This raises the monthly payment amount, but the interest rate is unaffected.

Raised Interest

A different way to eliminate the upfront closing costs in a mortgage refinancing is to raise the interest rate. The lender receives their closing payments through the increased interest instead of collecting the funds at the closing table or increasing the principal.

What Are the Pros and Cons of a No-Closing-Cost Refi?

With the various options available to roll your closing costs into your principal or interest rate, it's important to understand the pros and cons of refinancing without upfront closing costs.

Pros

When money is tight, you may have the need to refinance sooner rather than waiting to save up for closing costs. In the time you need to save, mortgage rates could potentially increase and you will continue to pay your existing mortgage while you are trying to set money aside. A no closing costs refi allows you to refinance your mortgage immediately, even if you don't have the cash for upfront closing costs.

Cons

A no-closing-costs refi usually ends up costing more over the life of your loan than if you pay the costs up front. If you roll the closing costs into your principal, it raises the total amount of borrowed funds that you must pay interest on over the life of your loan. If you cover your closing costs through an increased interest rate, you are paying a higher percentage on your total loan over the full term of your mortgage, which generally costs more than the original closing costs would have.

When Should You Consider a No-Closing-Cost Refi?

Although the overall cost of a mortgage refinancing that defers the upfront closing costs may be higher, there are still scenarios where a no-closing-cost refi makes sense.

You're Moving Soon

If you plan to sell your home within the next five years but you need the funds from a refinancing in the short term, a no-closing-cost refinance may be wise. Using a higher interest rate is a good choice because you won't be in the home long enough for the interest payments to greatly exceed what you would have paid in upfront costs.

You're Renovating Your Home

If you have some home improvement projects to tackle but don't have the funds for them, a no-closing-costs refi might make sense. You may end up paying less by accepting a higher interest rate or rolling your closing costs into the principal than you would taking out a home equity loan. This is especially true if the new refinanced interest rate is close to or less than the original rate.

Your Original Mortgage Is an ARM

If you have an adjustable-rate mortgage as your original home loan, a no-closing-cost refinance will help you to convert it to a fixed-rate mortgage. A fixed rate is better in the long run, as it locks your interest rate in, while an ARM will continue to increase. If you notice that interest rates are starting to creep up, it may be wise to grab a no-closing-cost refi now instead of waiting to save up the upfront fees.

Choosing a No-Closing-Cost Refi

Refinancing your mortgage can yield important financial benefits. If refinancing is the right choice for you to reduce debt, take on new projects, fund major purchases, or restructure your existing mortgage terms, you should take a close look at your financial situation and long-term plans to determine whether you should pay the upfront closing costs or defer them. If cash on hand is an issue and time is of the essence, financing your closing costs over the term of your mortgage or increasing your interest rate to offset the closing costs are both viable alternatives to paying upfront.