Why we refinanced: 3 homeowners' stories (© Gregor Schuster/Getty Images)

© Gregor Schuster/Getty Images

If you're shopping for a mortgage, you've probably run into "no-fee" mortgages. They're also called "zero closing cost" or "no closing cost" mortgages. All of these phrases are downright misleading.

"There is no such thing as a free lunch or a free mortgage. Everybody involved finds a way to get paid," says David Donhoff, a mortgage broker with Leverage Planners in Kirkland, Wash.

No-fee mortgages are not, as the name implies, mortgages without fees. The term is misleading, says Richard Booth, a certified mortgage banker with America's First Funding Group in Neptune, N.J. "With all that has occurred in the lending world over the past several years, my industry needs to be doing it better and more transparently."

A no-fee mortgage lets a borrower finance some or all of the costs of getting the mortgage in exchange for a higher interest rate. Is it right for you? It depends on your situation. We'll show you how to decide.

Financing a home or refinancing a mortgage costs money. The charges vary, depending on where you live. They include the lender's fees (origination fees), which can be as much as $1,600, plus other costs: title insurance, an appraiser's service, taxes and insurance. (Here's the full list from the Federal Reserve. The fees can total $4,000 or more.

The options
Here's a summary of the three ways to pay the fees, with pros and cons: 

1. Pay in cash at closing. The simplest and often cheapest approach is to pull out your checkbook when you sign your mortgage contract and write a check to cover the costs.

  • Pros: If you have the cash, this may be best because you can avoid financing charges.
  • Cons: You'll need to produce several thousand dollars. Also, as you'll see in a minute, if you refinance again or sell soon, there's a chance you could save by not paying cash.

2. Add the fees to your loan amount. When lenders talk about "rolling in" your fees, this is what they mean. Say you're borrowing $180,000 to buy or refinance your home. The loan fees are $3,000. Roll them together and your new mortgage balance becomes $183,000. You repay the increased balance with interest on the entire amount.

  • Pros: No cash required. Spreading the fee across your monthly mortgage payments lets you soften the immediate financial impact of the mortgage purchase.
  • Cons: You're taking on extra debt, and the cost of financing that larger amount is worked into your monthly payment.

3. Pay a higher interest rate (no-fee option). You're financing your fees again, but instead of adding to the loan balance, you accept a slightly higher interest rate.

  • Pros: Your loan balance stays the same. The interest you pay on the fees qualifies under the federal income-tax mortgage deduction.
  • Cons: You pay a higher interest rate on the entire mortgage.

Shopping for choices
Is the no-fee option the smartest consumer decision? That was the question Marco Casalaina asked in August when he wanted to refinance the $338,000 mortgage on the San Francisco condo that he bought in 2010.

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Casalaina had been hearing about no-fee mortgages and was intrigued.

"I had a friend who had gotten a no-fee refinance for a low rate, so he got me into it. It wasn't an absolute requirement, but it was an idea I had in my head," he says.

He did some shopping. You can save by comparing offers because interest rates vary by as much as a percentage point for the same mortgage product, says David M. Harrison, a finance professor at Texas Tech University who teaches courses on real-estate finance and investment.

Here's an example: On a $400,000 mortgage, fixed at 3.5% over 30 years with a monthly payment of $1,796, your rate might rise, for example, to 3.625%, or to $1,824 a month — a $28 monthly difference — to cover $2,000 in loan fees, says Michael Moskowitz, president of Equity Now, a New York mortgage lender. "It's a simple trade. You get $28 more a month in your payment, but your lender is giving you $2,000 more on the $400,000 loan."

Casalaina got quotes from his bank and brokerage company and asked for detailed statements of the fees included with each. He also filled out the form on a lending website, resulting in a flood of phone calls from salespeople.

"Within the first 10 minutes, I got maybe three calls," he says.

He compared the interest rates on all the offers, with and without fees included. One, a "zero-fee" option from the online site, appeared substantially lower, even with all fees included in the rate. But there was a twist: The offer required a nonrefundable processing fee of $495.

He kept asking questions. The $495 would be applied to his loan fees if he went ahead with the loan, the lender told him.

"That was unusual. It really sketched me out a little bit," Casalaina says. What if he decided the loan wasn't for him? Would the loan broker keep the money? What if he paid it and the lender didn't follow through, or demanded a higher rate or more fees at the last minute?

Read:  Why won't my lender work with me?

He read online reviews — some negative, others positive — written by consumers who had used that lender, including one from a borrower whose $495 fee was refunded. The lender was well-established, which helped him feel safe, and the rate offered was low enough, even with fees included, that he decided to take the chance. The transaction, while not yet finished, appears to be on track, he says.

Assessing the no-fee option
Comparing interest-rate quotes with and without fees included, as Casalaina did, is one way of deciding. You can refine the process even further, though, by figuring out how soon you'll pay off the fees with a no-fee loan.

The "break-even" date matters because it determines whether you'll end up ahead with a no-fee loan. Here's why: If you sell or refinance before your monthly payments have paid the fees, you're the winner. You got the loan more cheaply than you would have by paying the fees in cash.

But after the break-even point, this is no longer true, because you keep paying that extra interest.