Dear Dr. Don,
I have a mortgage with a 5.5 percent fixed rate of interest with 27 years left on a loan balance of about $145,000. If I refinance at a lower rate, is it possible to get a fixed rate with no out-of-pocket costs? Please help me decide what to do.
-- Jessica Jiffy
I think the news here is positive for you, but there's no free lunch, as they say. The question involves the method of payment. The lender can include the costs in the loan balance or the interest rate or use a combination of both. Even with a no-closing-cost refinance, there are usually expenses to be paid at closing. These might include per diem interest, title insurance, homeowners insurance, initial funding of an escrow account and governmental transfer taxes. It is important to understand you will pay closing costs one way or the other.
So-called per diem (translated from "per day") interest expense can affect both the old loan and the new one. It's the interest expense often missed by the scheduling of monthly payments. If you close on the 5th of the month, you'll owe five days per diem interest on the old loan and the balance of days in the month in per diem interest on the new loan.
While this does increase the amount owed at closing, it shouldn't influence a decision whether to refinance.
If you're now required to make escrow payments for taxes and insurance, avoiding an escrow account on the new loan may increase the interest rate on the refinancing. That's because of the lender's increased risk exposure. Also, the lender may require you to pay an upfront fee to avoid escrow. Think about it this way: Anything that raises your interest rate lowers savings from refinancing.
You also must have sufficient equity, or value, in the home to make it work. Generally, you want a loan-to-value ratio of no more than 80 percent, so the lender won't require private mortgage insurance.
Finally, ask yourself how long you plan to be in the home. As I write this reply, Bankrate's national average for a 30-year fixed-rate mortgage is 4.54 percent. You should shoot for something between both of these rates.
While there should be enough of a spread between the new rate and the old rate to capture interest savings over time, you must remain in the house and stick with the loan to collect the expected savings.
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