Mortgages are traded on the securities market at the market rate, which is called "par". The market will pay what's called "an above par premium" (called yield spread premium) for rates in excess of par. Mortgage lenders can then turn around and use this money to pay for the typical costs of closing - origination fees, appraisals, credit reports, title insurance and attorney's fees.

For example, let's assume that a couple purchased a home in 2002 with a $200,000 mortgage at an interest rate of 7.25% and paid closing costs. Today let’s assume the market interest rate has fallen to 6.50%. It doesn't make a lot of sense to pay closing costs a second time for only a ¾ % drop in the interest rate. However, this same couple could refinance with no closing cost and get a rate of approximately 6.75%. This would save them approximately $100 per month and cost them nothing!