You may have seen ads for a "no cost refi" loan lately, a mortgage program that promises no fees or out-of-pocket expenses when you refinance your existing mortgage.

While this type of offer is by no means a new concept, it's definitely a subject worth revisiting to ensure people understand what they're getting when they choose a no cost refinance option.

A no cost refinance is essentially a loan transaction in which the lender or broker pays settlement costs, including typical fees such as processing and underwriting fees, appraisal fee, title/escrow fees, loan origination points, and so on.

However, a bank or lender may also "bundle" your closing costs on top of your loan amount, increasing the size of your loan, and effectively making it a "no-cash loan."

Though you may avoid out-of-pocket expenses and upfront fees, these costs are not lender paid, and the loan is not a true no cost loan. You simply pay the fees over the life of the loan instead of at closing. And you're stuck with a higher loan amount to boot! Not necessarily a great deal.

So how do banks and lenders make up for the absence of fees that normally must be paid?

Assuming the lender actually pays your closings costs, doing so will bump up your interest rate, sometimes dramatically, in order to make up for the missing fees that are typically charged at closing.

It's a simple trade - pay nothing now, but pay more over the life of the loan in the form of a higher mortgage rate.

For some borrowers, a no cost loan is a necessity because they don't have the required funds to pay all the fees, but for others, it's a decision that will need to be made during the loan process.

And note that no cost refinances will vary by lender. Some programs may cover all costs, while others may still charge you for certain third-party fees such as appraisal/inspection, title, escrow, and even mortgage points!

Mortgage brokers can also set up a no cost refinance for you, adjusting their yield-spread premium(commission) to the point where they make enough money to offset the fees associated with the loan.

Let's look at an example to illustrate the no cost refinance program:

No cost refinance: 6.5% mortgage rate, no fees. Standard refinance: 6% mortgage rate, $7,500 in fees.

Imagine you're able to qualify for a mortgage at an interest rate of 6% on a $500,000 loan, paying a point to the lender and another $2,500 in closing costs, totaling $7,500. While this may seem like a large upfront cost, the trade-off may be a lower interest rate.

With a typical "No Cost Refi" mortgage, you'll cruise through the process without paying a dime, but you may end up with an interest rate of 6.5% or higher for the very same loan.

Assuming you make the interest-only payment each month, you'll pay an additional $200 a month, or roughly $2,400 more annually if you select the "no cost refi" at an interest rate of 6.5%.

Is a no fee refinance a good deal?

This is the point where you need to ask yourself what you plan to do with the property and the mortgage. If you're planning on moving or upgrading to a more expensive home in just a few years, or if you're the type that refinances often, paying upfront costs for a lower interest rate may be a losing endeavor. For you, a no cost loan may be a good choice.

But if you plan to stay in the home for five or more years (or whenever the break-even point takes place), it would make sense to pay a little more upfront for future savings. After all, that $200 discount each month might ease your budgeting woes in the future, and amount to some serious savings if you stick with the mortgage for the long-haul.

Remember, no cost loans aren't inherently good or bad. Their associated benefit or cost will really depend on your unique financial situation, what the fees are, and what the interest rate impact will be. Make sure you do the math and compare options before signing on the dotted line.