Before refinancing, weigh fees against savings
Potential refinance fees
- Application fee
- Loan-origination fee
- Appraisal and inspection fees
- Attorney and title fees
If you have seen interest rates drop since signing your mortgage, refinancing to get a lower rate and lower monthly payments may seem like a no-brainer. The costs involved with refinancing, however, complicate the choice and make the decision more difficult.
When refinancing your mortgage, you actually agree to a brand-new mortgage that replaces your current loan. Because of this, the fees associated with a refinance are similar to the fees and closing costs that accompany a first mortgage.
How to assess refinance fees
The Federal Reserve lists several fees that may be included with a refinance transaction, depending on the state in which the loan is originated and on the lender that originates the loan. These costs can include an application fee, paid even if the loan is denied; a loan-origination fee, which is charged by the lender or broker; and appraisal and inspection fees. Other costs that can be part of the refinancing transaction include attorney fees as well as homeowners and title-insurance fees.
In all, these fees could cost roughly 5 percent of the loan amount (the remaining principal on your current mortgage). If your current mortgage includes a prepayment penalty, those fees could climb even higher.
Just like with a first mortgage, borrowers also have the option of purchasing points to reduce interest rates. One point is equivalent to 1 percent of the new loan amount. This results in higher upfront costs, with the potential of long-term savings.
There are ways to reduce refinancing fees, depending on your lender and your situation. Some lenders may be willing to waive or negotiate certain fees, especially if they may otherwise lose a current borrower to another lender. Compare different lenders to see what options are available.
If you currently have a Federal Housing Administration (FHA)-insured mortgage, you may be eligible for an FHA Streamline Refinance. This program requires less underwriting and documentation than traditional refinances, and therefore results in lower fees.
How to tally estimated savings
To determine if it is worthwhile to refinance your mortgage, a good starting point is to see how long it would take you to recoup your fees.
For example, say you decide to refinance when you have $200,000 remaining on the principal of your current mortgage. If the fees will cost 5 percent of that amount, you will need to pay $10,000 in fees to obtain the new mortgage. If the new terms of your refinanced mortgage lower your monthly payment by $200, it would take 50 months — more than four years — to realize $10,000 in savings.
Even when you reach that point, however, you may not have technically broken even, depending on the terms of your mortgage. If you were five years into a 30-year mortgage at the time of your refinance, and you refinance to a new 30-year mortgage with lower payments, it will take five years longer to pay off your refinanced mortgage, compared to the terms of your original one.
You also will restart the amortization process, meaning you will pay little toward your outstanding principal early in your refinance, with most of the monthly payment going toward interest payments. A bright spot in that scenario is that those interest payments are usually tax deductible.
None of these factors may be deal breakers, and refinances can still create tremendous savings for many homebuyers. All of these issues, however, should be considered before jumping into a refinance, and speaking with several lenders and a financial adviser can help ensure that you make the best decision for your exact situation.