For many homeowners, refinancing their home mortgage is looking mighty tempting with the market's low rates. However, it's important to understand that a lower monthly mortgage payment and a lower interest rate does not automatically mean you are saving money right away. Why?
Because it costs to refinance and these upfront costs must be recovered over time before you actually start to incur real savings. So if you check out our previous blog, "Is Refinancing Right for You", you'll find some topics to ponder when it comes to refinancing. This blog will specifically cover the costs of refinancing and the break-even point, or the point at which the savings from a lower interest rate offset the upfront refinance costs.
What Does It Cost to Refinance?
Remember what you went through to get your first mortgage? Well a refinance isn't all that different; much of the process is the same, as well as the types of costs. Refinancing costs vary by state and of course by lender, but they typically range from about 2% to 6% of the mortgage amount.
Some of the typical fees include:
- LOAN ORIGINATION FEE
This is the fee charged by the lender to evaluate and prepare the loan.
- LOAN DISCOUNT POINTS
A point is equal to 1% of the loan amount. A borrower can choose to pay a point(s) to reduce the interest rate of the loan.
- APPRAISAL FEE
This will cover the appraisal of your home and is required by the lender to ensure that the home is worth at least as much as the loan amount. These fees are often non-refundable, even if the loan does not go through.
- INSPECTION FEE
A home inspection is not required everywhere, but many lenders do require them to secure the structural condition of the property. Some states require specific inspections.
- HOMEOWNERS INSURANCE
Most lenders require that a homeowners insurance policy be in place at the time of settlement. Most homeowners already have a policy, so when refinancing the lender will only need proof of the policy.
- TITLE SEARCH AND TITLE INSURANCE
A search must be done to ensure that you are the rightful owner of the property, and therefore have the right to refinance. Title insurance will protect the lender's investment in your mortgage should any problems arise due to errors in the title search. If it hasn't been that long since you first purchased your home, ask the title company that is currently carrying your title insurance policy about reissue rates, or the discounted rate on title insurance. This may reduce your cost on title insurance.
- SURVEY FEE
Lenders will require a survey fee to verify the official boundaries of the property, improvements on the land, and to ensure that your lot has not been infringed upon by other structures.
- PREPAYMENT PENALTY
Some lenders will charge a fee should you refinance and pay off your existing mortgage early.
To get a full view of the costs associated with refinancing your mortgage, make sure you read your Loan Estimate form thoroughly. A Loan Estimate is a form your lender is required to provide to you within three business days of receiving your loan application.
The Loan Estimate form discloses all the information about your loan in an easy-to-read format. The form will include your estimated interest rate (or locked-in interest rate), loan terms, monthly payment, closing costs, and more. The purpose of this form is to fully educate the borrower on their loan so the borrower can make a fully informed decision.
When Will You Reach the Break-Even Point?
When you refinance, one of the most common goals is to save money. So at what point do you begin to incur real savings? This is your break-even point, and it's all uphill from here.
EXAMPLE OF A 30 YEAR FIXED RATE MORTGAGE
To calculate your break-even point, let's say you have a 30 Year Fixed Rate mortgage:
- Principal: $400,000
- Interest Rate: 6%
- Monthly Mortgage: $2,398.20
Say five years have gone by, and now your principal is $372,217.43, and you're looking to refinance into another 30 Year Fixed Rate Mortgage.
- Principal: $372,217.43
- Interest Rate: 4%
- Monthly Mortgage: $1,777.02
- Savings per month: $2,398.20 - $1,777.02 = $621.18
And say your total cost to refinance is about $9,500 (paying 2 points, closing costs of about $2,500). Obviously this is just an estimate, and many other factors may affect this number such as taxes, closing costs, etc.
Your break-even point would be $9,500 divided by $621.18 = about 15 months.
After you refinance, it will take about a year and some change before you start to incur real savings. If you plan on moving out before then, refinancing may not be your best bet. To get a good look at detailed numbers as it pertains to your current situation, consult a Loan Officer.
Check out our easy-to-use mortgage refinance calculator to help you decide whether refinancing could be a good option.