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I see the ads in the mail all the time. The big, bold, red lettered, over sized postcards telling me that I can refinance my mortgage to a lower rate and save a bundle. Sure, it sounds dandy; after all, we are a society motivated by low payments. In our collectively conditioned mindset, the lower the payment, the better the deal. Yet, is a mortgage refinance always worth it?
First, you have to account for the fees associated with the refinance. In this area, there are several factors to consider.
Application fee: $75 - $300
Appraisal: $150 - $400
Survey: $125 - $300
Lender Attorney fees: $75 - $200
Title Search: $450 - $600
Loan origination fee: 1% of the total
Moreover, those fees increase by 1 to 3 percent when accounting for mortgage insurance and points on FHA or conventional loans. If you are using a VA loan, you are subject to a funding fee of nearly 3 percent of the refinance price, tacking on some hefty fees that take time to recoup.
For example, if you were financing your home from 5 percent to 4 percent APR using an FHA refinance, with 23 years left to a 30 year note; you reset the clock on your amortization table, get a lower payment, but wind up paying more in the end once you add on the seven years worth of interest and up front fees -- no matter what type of refinance you do.
If your current balance was $200,000, your payment would go down $95.17 a month, taking approximately 40 months (3 years) to recoup your initial investment, not including the loan origination fee, which would add on nearly another full year.
Despite this gamble, I have seen homeowners throw away precious equity all in the name of a lower monthly payment. Many of them cash out their equity on a refinance to make home improvements, essentially undoing all the good a lower monthly payment brings.
I have also seen the cardinal sin from homeowners who say they will apply their savings to their principal and pay off their mortgage faster. In point of fact, only a handful actually do this, but the truth is that many of them didn't need to refinance their mortgage to apply the extra cash to the principal to begin with -- meaning they are out several years worth of money that they didn't need to spend.
If the same home buyers were to have applied the same fees spent on a loan refinance, they could have already substantially paid down the principal. If the money is liquid enough to do this, instead of rolling it into the loan -- an even worse choice -- why wait?
Of course, refinancing for some does make sound financial sense. The trick is to not be seduced by mail outs and lender promises of lower monthly payments. Use an objective third-party calculator like the one found on Bankrate.com to evaluate whether or not a mortgage refinance makes sense for your wallet now or later.
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- Loan origination fee