Refinancing a mortgage could result in a lower monthly payment or a reduction in your interest rate. That could save you money, but is the cost to refinance your mortgage worth it? Here's what you need to know.
What Does Refinancing a Mortgage Cost?
Refinancing a mortgage means getting a new loan to replace your mortgage. The fees you may be charged for a refinance loan are similar to original mortgage costs. On average, homeowners can expect to pay 2% to 3% of the loan amount to refinance a mortgage. Refinancing a $300,000 home loan, for example, may cost $6,000 to $9,000.
These are costs that would be due at or before closing. Inspection and appraisal fees, for instance, you'd pay during underwriting for a refinance loan.
[Read: Best Mortgage Refinance Lenders.]
Generally, any type of refinance loan will require closing costs, including conventional mortgages, USDA loans, VA loans, adjustable-rate mortgages and FHA loans. The amount you pay can depend on the amount you're refinancing, what type of loan you currently have and the type of loan you're refinancing into, what your lender charges for closing fees and where you live.
"Not all of these fees are created equal, so you should request a breakdown when shopping around," says Brian Walsh, manager of financial planning at lender SoFi. "Lenders might be willing to waive the application fee or lower the origination fee. Even if a specific lender is not willing to lower their fees, having a detailed breakdown from each lender will help you make an educated and informed decision."
Take note, these costs don't include what you might pay for private mortgage insurance when refinancing. Private mortgage insurance typically applies to conventional home loans when you put less than 20% down, but can be removed when you reach 20% equity.
When to Refinance a Mortgage
The most important step in the refinancing process isn't necessarily getting a loan; it's determining whether refinancing makes sense in the first place. That involves looking at your short- and long-term financial goals, current mortgage terms, overall market conditions and reasons for refinancing, says John Dustman, senior vice president of consumer direct lending at Axos Bank.
For instance, you may be considering a refinance to try to save money on homeownership costs or to convert an adjustable-rate mortgage to a fixed-rate loan. Or you may be weighing a cash-out refinance to tap equity for repair or renovation projects. Refinancing may be necessary after divorce if your former spouse wants their name removed from the original mortgage.
[Read: Best Mortgage Lenders.]
Conduct a break-even analysis to compare the costs of refinancing against the potential monthly interest savings as a good starting point for making a decision. The break-even point is where you recoup what you spent on refinancing closing costs in the form of money saved in interest and monthly payments.
Here's a basic example: Assume that it's going to cost you $3,000 to refinance your mortgage and doing so lowers your mortgage payment by $150 each month. Divide $3,000 by $150 and you get 20, which represents the number of months you'd need to recoup closing costs with mortgage savings.
If you're planning to move within the first year or two after refinancing, you may not see any tangible return from lowering your interest rate, depending on where your break-even point falls. On the other hand, if you're planning to stay in the home long-term, you'd need to look at the lifetime savings.
This is where you'd factor in what you've paid on the loan already, your new mortgage rate and monthly payment and the new mortgage term. Say your original mortgage was $300,000 with a 30-year term. Your starting interest rate was 4.25% and you're 10 years into your loan.
Refinancing into a 20-year term at 4% would trim $28 per month off your payment. But it would cost you an additional $1,827 in interest, compared with sticking with your current mortgage terms. You'd see a small monthly savings, but none where your interest is concerned.
Now, assume that you're only five years into the same mortgage term and you decide to refinance into a 20-year loan at 4%. In that scenario, your monthly payment would go up by $178, but you'd save more than $4,000 in interest over the life of the loan. Running different scenarios through a refinance calculator can help you decide whether refinancing makes sense.
[Compare: Mortgage and Refinance Rates in Your Area.]
Think about the type of loan term you're planning to refinance into. "A large savings can be realized if you reduce your term of the loan," Dustman says. "The flip side to this is that if you extend your term for several years beyond the maturity today, even at a lower rate, you may end up paying higher interest over the longer period of the loan."
Can You Refinance Without Closing Costs?
Refinancing with no closing costs is available. You might assume these loans charge zero closing costs to refinance, but that's not exactly accurate.
"With a no-cost refinance, the lender essentially covers the closing costs rather than having to pay them yourself," Walsh says. "In return, you will generally pay a higher interest rate."
No-closing-cost refinance could be an advantage if you need to refinance but don't have a lot of cash to cover closing costs. What you have to consider, however, is how such a loan could affect the amount you pay over the long term. A higher interest rate means more interest paid over the life of the loan, even if the difference in the rate is only fractional.
For example, say you refinance a $200,000 mortgage balance into a 15-year term. You could pay a 4% rate with $4,000 in closing costs paid out of pocket, or 4.25% with a lender credit for closing costs. If you opt to accept the higher rate, you'd hang on to your $4,000 for closing but pay approximately $4,500 more in interest at the higher rate, an overall higher cost of $500.
The other scenario to consider is having the closing costs rolled into the loan, in lieu of a higher interest rate. In that case, your rate may not increase, but adding closing costs to the loan means a higher loan amount. That could raise your monthly payments. Besides that, you're also paying interest on the closing costs over time.
How to Save Money on Mortgage Refinancing
It's always a question of whether the costs of mortgage refinancing will outweigh the benefits. But there are some ways to bring the cost of refinancing down.
Improve your credit score. Credit scores are one of the most important factors lenders consider when you apply for mortgage refinancing. Your credit score, along with your income and other financial details, can determine whether you're approved for refinancing and the interest rate you'll pay. The higher your score, the lower the rate you may qualify for, which could mean less interest paid to refinance.
To help boost your score, the most impactful factors are payment history and maintaining a 30% or lower credit utilization. Credit utilization measures how much of your available credit you're using. Paying bills on time monthly and lowering the balances on your credit cards could add points to your credit score, which could make you a more attractive candidate for refinancing.
Compare lenders carefully. Every lender is different when it comes to rates and terms for refinance loans. So take your time and shop around to find the best loan options. Start with your bank or credit union, but get rate quotes from other financial institutions, including online lenders. Specifically, zero in on the rates lenders offer for different types of refinance loans and the fees associated with each one.
Check your bank for refinance discounts. Some banks may offer an incentive to customers to encourage refinancing -- a discount or waiver of certain fees. For instance, your bank may cut you a small break on your interest rate or not charge a loan origination fee. Check your bank's website or call your nearest branch to find out if any special promotions for refinancing exist.
Negotiate refinance fees if possible. Once you've chosen a loan, don't accept the closing costs at face value. Reach out to your lender to see if any of the various costs associated with refinancing are negotiable. Some, like local recording fees or property taxes that must be prepaid, may be set in stone. But others, such as the application fee or credit check fees, may be up for discussion.
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