Mortgage refinancing: are costs worth the savings?
More and more homeowners opt for refinancing at the time of low interest rates. The hassle and expenses associated with refinancing are justified if:
- You bought your home at the time of high interest rates. Now they have dropped and you want to take advantage of it.
- You want to change from an ARM to a fixed-rate mortgage or vice versa.
- You want to convert to an ARM with a lower rate or more favorable payment caps.
- You want to shorten the term of your loan so that you can repay it quicker.
- You have built equity in your house or possibly it has risen in value since the time of the purchase and you want to cash out equity to pay for your child’s education, pay off other debts or make home improvements. In this case you choose cash-out refinancing.
- You want to consolidate all your debts into one low interest mortgage.
The general rule of thumb is that refinancing is a reasonable option if you refinance into a loan with a rate at least 2% lower than the rate on your current mortgage and you plan to stay in the house no less than three years. Still, you need to do relatively simple math if you want to straighten things out for your individual situation. Say, if you want to recoup your closing costs of $2,000 that allow you to refinance into the loan that saves you $100 a month in mortgage payments, you will need to stay at least 2,000/100=20 months in your home just to break even.
So it is important you examine carefully all your refinancing costs and see if you can cut this figure:
- Start by approaching your current lender. More often than not, he/she will agree to waive certain fees and offer you his/her own refinancing package.
- If you have good credit, you should be able to avoid application fees imposed by the lenders to cover the initial costs of processing your loan.
- Title search. You need to cover the cost of examining the public record to confirm ownership of the real estate. Title insurance insures the policyholder in a specific amount for any loss caused by discrepancies in the title to the property. Most often the company carrying your current insurance can re-issue it at a rate that saves up to 70% on this type of expense, though the title industry does not promote this information to the general public. For example, if the latest title search was performed 5 years ago, you most probably do not need another full search, although title insurers sometimes severely restrict the eligibility period for a reissue discount or demand presentation of the prior title policy to the title agent.
- Loan origination fees charged for the lender’s work in processing your loan.
- Discount points that usually represent upfront payments of 1% of the loan amount. The more points you pay upfront, the lower your APR is going to be. Lenders sometimes offer no-pointers, mortgages where you do not pay any points, but beware of the pre-payment penalties some of them carry. Anyway, you should always do math calculations to help you figure out if saving money today on points will offset a higher APR tomorrow. A lot depends on whether you plan to invest the amount of money you saved on points and on lower interest payments. As a rule, refinancing is available with 1 or fewer points, while a new-home loan will cost 2 or more.
- Appraisal fee for an estimate of the value of the house.
- Prepayment penalty for your existing loan can be a significant cost and come up to six months interest on 80% of your balance. This expense is the first thing to think of when you contemplate refinancing. Luckily, some states prohibit this practice.
- The hidden costs include loss of tax savings due to the drop in tax-deductible interest payments.
When you shop around for the rates, keep in mind that there are “refi” or “consolidation” lenders who advertise that they offer better refinancing terms than regular lenders.
You should check that all the closing costs are disclosed to you in a clear and transparent manner. Sometimes lenders try to entice borrowers with a “no-cost” refinancing option that only means lender fees will be included in your new loan or the interest rate will be higher to reimburse the lender for his costs incurred in the closing process.
Since refinancing also means a lot of time and effort, you should thoroughly work through the numbers before you make a big financial decision like that. To get exact cost estimates, you can turn to Web-based free calculators or have your loan officer run the numbers for you.