Refi closing costs get rolled into either your mortgage rate or its balance if you don't pay them up front. These costs cover everything from closing fees to recording fees to compensation for the loan broker or salesperson. According to the 2012 national closing cost survey conducted by Bankrate, the average $200,000 mortgage cost $3,754 in fees.
Paying Cash at Closing
You can avoid having closing costs built into your loan by paying them in cash when you close. When you do this, you keep your mortgage balance the same by showing up to the closing with a check that pays the costs. Doing this gives you the lowest overall payment, but you'll be out the money.
Financing Closing Costs
Financing your closing costs is one of the methods that you can use to close your loan with little or no out-of-pocket cost. If you were to refinance a $200,000 loan and wanted to build in $3,900 of closing costs, you would take out a $203,900 loan. That way, you just pay off the closing costs over the life of the loan. Remember, though, that you'll be paying interest on those charges over the life of the loan.
Higher Interest Rates
You may have the option of having the closing costs paid for you, letting you refinance a $200,000 mortgage into another $200,000 mortgage without taking any money out of pocket. When you do this, though, the lender charges you a higher interest rate. This difference, called a yield spread premium, gives the loan officer the money to pay your closing costs for you as well as to potentially put some profit in his pocket.
Making a Choice
While it's usually cheapest in the long run to pay the costs up front, that might not be the best option for you, especially if you don't have the money to lay out. For instance, consider a $200,000 30-year fixed mortgage at 5 percent interest. If you paid the $3,900 in closing costs out of pocket, your principal and interest payment would be $1,074. If you financed the closing costs in and took out a $203,900 mortgage, you'd pay $1,094.58 per month, which works out to an extra $7,537 over 30 years. Choosing to have it built into your rate might bump the interest to 5.3 percent, which would leave you with a monthly payment of $1,111, costing you an extra $13,308 over 30 years. However, all of that money would be tax-deductible interest. If you sell your house or refinance before your loan is paid off, you might not end up spending the entire extra cost, and you'd be benefiting from the interest deduction in the meantime.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.