Considering a Refinance? Weigh the Cost Against Interest Savings
- Published on
- 12 min read
-
Gina Rodrigues Contributing AuthorClose
Gina Rodrigues Contributing AuthorGina is a freelance writer and editor who specializes in real estate and personal finance. She brings more than ten years of experience as a licensed agent and property investor. When she isn’t writing, she can be found tending to the sheep and chickens at her suburban homestead outside of Seattle. Gina holds a B.A. in English from California State University.
At HomeLight, our vision is a world where every real estate transaction is simple, certain, and satisfying. Therefore, we promote strict editorial integrity in each of our posts.
Your neighbor’s been bragging about her ultra-low interest rate, and now you’re tempted to lower your monthly mortgage payment by refinancing. But the seemingly endless list of closing costs you paid for your current home loan still haunts you. Is it worth refinancing your home loan and paying those fees all over again?
With a refinance, you take out a new loan on your house and use that loan to pay off your existing home loan. Getting a refinance isn’t free, but even taking the cost into account, you could end up saving in the long run.
For all the details, we spoke with Richie Helali, HomeLight’s mortgage sales lead, about estimating refinance costs, shopping around for the lowest fees, and weighing whether or not you should refinance.
Refinance closing costs generally run 1% to 1.5% of your loan amount
Expect to pay around 1% to 1.5% of your new loan balance toward closing costs for a refinance loan, says Helali. For example, if you have a $250,000 refinance loan, you’d likely be on the hook for between $2,500 and $3,750. That expense includes both lender fees and third-party settlement costs like title fees.
Helali also notes that the way you structure your loan could drastically affect the cost of your refinance. You may have the option to pay extra fees in the form of discount points to lower your interest rate. Discount points are a type of prepaid interest denoted as a percentage of the loan amount. In exchange for paying this interest fee upfront, the lender reduces your rate. For example, instead of a rate of 2.875% with no points, you could opt for a lower rate of 2.5% by paying a 1% of your loan amount upfront. This tactic is sometimes referred to as a “buydown.”
Your interest rate can influence how much you pay in closing costs — and vice versa
If your number one priority is to pay less in upfront fees, you may be able to opt for a higher interest rate with a lender credit that pays for some or all of your closing costs. If your primary goal is the lowest rate possible, you could choose to pay down your rate in the form of discount points. This balancing act, says Helali, can help you adjust the refinance cost based on your financial goals.
For example, your lender could offer two rate quotes for a 30-year fixed-rate mortgage. The first option, at a rate of 2.5%, costs $10,000 in closing fees. The second option, at a rate of 2.875%, has a lender credit covering all closing costs. The lower interest rate comes with higher closing costs while the higher interest rate comes at a lower (or in this case, zero) upfront cost. How would the different rates affect your interest fees over the life of the loan?
For a loan amount of $250,000 and a rate of 2.5%, you’d pay a little over $105,000 in interest over the life of the loan. In comparison, a 2.875% rate would result in more than $123,000 in interest fees at the end of the 30-year loan term — a difference of approximately $18,000.
No-closing-cost refinance loans can eliminate upfront fees
Some lenders promote no-closing-cost refinance loans as exemplified above, but the term is a misnomer. With this loan type, refinance costs still apply. You simply don’t pay for the fees upfront at closing.
No closing cost refinance loans work in one of two ways:
- You pay a higher interest rate and receive a lender credit that covers your closing costs, or
- You wrap the fees into your mortgage by increasing your loan principal amount to cover the fees
While you won’t have to write a check for closing costs, it’s important to note that you could end up paying more over the life of the loan. With a higher interest rate, you’ll be paying more in interest fees.
Breaking down the cost to refinance
If the following closing costs look familiar to you, it’s because you’ve probably seen them before when you took out a mortgage to purchase your home. Refinance loan fees are “mostly identical” to the lender and third-party loan fees you’d see during a home purchase, says Helali. However, refinancing fees may be slightly lower— typically by 5% to 10% — than loan costs for buying a house, he adds.
| Lender fee | Fee description | Cost |
| Loan origination fee | The lender charges a percentage of your new home loan balance to process your refinance. | Refinance loan origination fees usually range from 0.5% to 1.% of the new loan amount.
Origination fees can vary widely depending on your lender and loan program. |
| Discount points | Borrowers may have the option to “buy down” their mortgage interest rate by paying this upfront fee. Discount points are calculated as a percentage of the loan balance.
According to Freddie Mac, it’s better to pay discount points if you plan to stay in your home long-term since they help to lower the total interest you’ll pay over the life of the loan. |
Discount point fees differ depending on your lender’s pricing structure, current market conditions, and the loan program you select.
One discount point equals 1% of the loan balance. For example, if your lender charges 1% (or one discount point) to lower the interest rate by 0.25% on a $200,000 loan, you’d pay $2,000 in discount points. |
| Credit report fee | Lenders will review your credit history before issuing a home loan. By pulling your credit report, the lender also obtains your credit score.
A higher credit score typically results in a better interest rate, which could save you interest fees over the life of your home loan. |
Expect to pay $15 to $35 for your credit report. |
| Appraisal fee | Your lender hires an independent appraiser to ensure the value of your home covers the new proposed loan amount. A mortgage is a secured loan, so your home serves as collateral if you default on payments.
A high home value in relation to the loan balance, or greater home equity, can result in a better interest rate for your refinance. For example, a homeowner who borrows $240,000 on a $300,000 home may be quoted a higher interest rate than someone who borrows $100,000 on a home of the same value. |
A residential home appraisal ranges from $400 to $900. |
| Prepaid interest charges | As soon as your refinance closes, you’re on the hook for daily interest charges on the new loan. You’ll pay for upfront interest due from the date of closing until the billing cycle begins for your first mortgage payment.
For example, your mortgage payment may be due on the first of every month. Let’s say you close your refinance on March 15th. You’d pay upfront for interest from March 15th to the end of March. Your first mortgage payment would be May 1st, which would reflect the interest fees for the month of April. |
The amount you’ll pay for prepaid interest depends on your loan amount, your interest rate, the date your refinance loan closes, and the date of your first mortgage payment. |
| Prepaid taxes and insurance (impound account) | Your lender may require that you deposit money into a type of trust account to be held toward payment of property taxes and home insurance.
Every month, part of your monthly loan payment will be directed to this lender-controlled account, sometimes referred to as an escrow account. |
The amount your lender collects depends on your property tax and insurance cost, along with how soon after settlement payments are due.
Federal regulations place limits on what lenders require you to deposit when setting up the account. |
| Third-party fees | Fee description | Costs |
| Settlement fee | You’ll pay a settlement agent, such as an escrow officer or real estate attorney, to facilitate your refinance.
The settlement agent handles the paperwork for closing, prepares documents for recording, transfers funds as instructed by the lender or borrower, and oversees other administrative tasks necessary for closing the loan. |
Depending on your settlement provider and location, expect to pay $295 to $1,595. |
| Title search fee | Prior to issuing title insurance, the issuing company conducts a search for title issues. Any issues discovered would need to be resolved prior to settlement.
Some potential title problems include:
|
The cost for a title search ranges from $75 to $100 on average. |
| Title insurance policy | When you refinance, your lender requires you to purchase a new lender’s title insurance policy. The policy protects the lender against title issues that relate to transfers of ownership, liens, and levies. | The cost of your title insurance will vary based on your home value and location, but you can expect to pay approximately 0.5% of your loan balance for a lender’s policy. Title insurance rates vary based on the loan amount and the title company’s fee structure.
If you purchased an owner’s title policy when you bought your home, you generally don’t need to pay for a new owner’s policy. |
| Recording fee | This fee covers the cost to record the deed of trust or mortgage with your local land records office. | The Home Buying Institute advises that recording fees average $125. Your cost may vary depending on your local recorder’s office fees and the number of pages in the recorded document. |
| Flood certification fee | To protect its investment (your home in the instance the lender takes ownership), your lender will want to confirm whether or not the property is in a flood zone.
If your home sits in a flood zone, your lender probably won’t refinance your home loan unless you purchase flood insurance. |
A flood certification costs between $12 and $18. |
| Government loan fees (FHA, VA, USDA) | Fee description | Cost |
| Upfront mortgage insurance premium (UFMIP) for FHA loans | Administered by HUD, UFMIP protects the lender in the event the borrower defaults on their loan. | HUD charges 1.75% of the loan amount for a single-family home. |
| Funding fee for VA loans | Since VA home loans don’t require mortgage insurance or down payments, the VA charges borrowers a funding fee to offset taxpayer costs for funding the loan program. | The funding fee ranges between 1.4% to 3.6% of the VA loan amount. The fee varies based on the loan type, loan amount, and whether it’s the borrower’s first time obtaining a VA loan. |
| Upfront guarantee fee for USDA loans | To obtain a USDA home loan, borrowers must pay this one-time guarantee fee. | For a single family home, the USDA charges a 1% upfront guarantee fee. |
Weigh the cost of refinancing against the benefits by calculating your break-even point
Here’s one factor to consider when weighing the cost to refinance: your break-even point. Based on how much you save every month by refinancing, how long will it take to recoup the closing costs?
Helali shares how to calculate your break-even point: Divide your refinance closing costs by the amount you’ll save each month on your monthly payment. The end figure tells you how many monthly payments it takes before you break even on your refinancing costs.
For example, let’s say closing costs on your refinance loan add up to $3,500. Mortgage rates have dipped to historic lows, and you calculate a savings of $400 per month with the new loan. Dividing $3,500 by $400, it would take just under nine months to recoup the costs.
On the other hand, let’s say the rates aren’t quite so low, and the monthly savings amounts to just $100 per month. With the same closing costs, it would take 35 months, or almost three years, to break even.
If you’re planning to stay in your home for well over three years, it could be worthwhile to refinance under either scenario. But if you’re thinking about moving in the next two years, the cost to refinance in the second scenario would be more than what you’d save every month.
You can save on closing costs by shopping around for both your lender and settlement company
Some fees, such as government recording fees and appraisal fees, aren’t negotiable. But you can still shop for the best deal by comparing fees between different lenders, settlement representatives, and title companies.
Compare different lenders and loan programs
When you’re shopping around for a refinance loan and comparing lender closings costs, weigh these factors:
Lender-specific fees
Separate the lender fees from the settlement costs and third-party fees so you can compare apples to apples.
“Specifically on a fee quote, one thing that’s really smart to ask about is, what are the lender-specific fees?” advises Helali.
“The reason I say, for the most part, to focus on lender-specific fees is that [those fees] —and the interest rate and the service level — are what’s going to differentiate one lender from another.”
Multiple rate and fee quote combinations from each lender
In addition to zeroing in on lender-specific fees, Helali suggests getting three rate quote combinations for each loan program you’re comparing:
- The lowest interest rate offered where you pay for all of the closing costs
- The (usually higher) interest rate offered where a lender pays for the closing costs, and
- A combination of the two — an in-between interest rate where you get a credit to pay for part of the closing costs
“It’s good to use that as a comparison to go to lender A, lender B, lender C just to see what the differences are,” Helali adds.
Your financial goals
When comparing lender programs, you’ll also want to factor in your reason for refinancing. Are you focused on lowering your monthly payment, or are you hoping to cash out to consolidate your debt?
If lowering your monthly payment is a priority, it could be worthwhile to pay discount points upfront for a lower interest rate.
On the other hand, if you’re paying off credit card debt with a cash-out refinance, you may want to opt for a lender credit and higher loan amount or interest rate to avoid paying for closing costs out of pocket.
Shop around for settlement services and title insurance
In many cases, a lender works with a preferred settlement agent and title company. When a new loan application comes in, the lender automatically sends the file to this preferred company. But Helali says you don’t have to use the company your lender recommends.
“One thing a lot of people don’t know in a refinance — a client can shop for their own title and escrow company,” he reveals. If you’re looking to save on closing costs, call settlement agents and title reps in your area to compare fees.
Ask about discounts you may be eligible for, such as a discount for repeat customers (if you’re refinancing with the same title company that holds the policy on your existing home loan). Also, if your home has been insured by a lender’s title policy in the past ten years, you may be eligible for a discounted substitution rate. When applicable, the title company reduces its rate when it covers an existing homeowner with a new mortgage. The title company may require proof of prior title insurance before issuing this discount.
Is the cost to refinance worth it? Factor in more than closing fees
All refinance loans have some manner of cost attached. Your best bet? Don’t base your decision solely on fees or solely on interest rates.
“Target the best fee and rate combination that works for you,” says Helali. Then compare your loan options to your current loan before making a decision. “It all depends on what [your] goal is, what the purpose of the refinance is.”
Header Image Source: (fizkes / Shutterstock)