If you are a homeowner who was lucky enough to buy when mortgage rates were low, you may have no interest in refinancing your present loan. But perhaps you bought your home when rates were higher. Or perhaps you have an adjustable-rate loan and would like to obtain different terms.
Should you refinance?
These FAQs will answer some questions that may help you decide. If you do refinance, the process will remind you of what you went through in obtaining the original mortgage. That’s because, in reality, refinancing a mortgage is simply taking out a new mortgage. You will encounter many of the same procedures-and the same types of costs-the second time around.
Would Refinancing Be Worth It?
Refinancing can be worthwhile, but it does not make good financial sense for everyone. There are many considerations such as how long you plan to stay in the house. Most sources say that it takes at least three years to fully realize the savings from a lower interest rate, given the costs of the refinancing. Depending on your loan amount and the particular circumstances, however, you might choose to refinance a loan that is only slightly different than the current rate. You may even find you could recoup the refinancing costs in a shorter time.
Refinancing can be a good idea for homeowners who:
- Want to get out of a high interest rate loan to take advantage of lower rates.
- Have an adjustable-rate mortgage (ARM) and want a fixed-rate loan to have the certainty of knowing exactly what the mortgage payment will be for the life of the loan.
- Want to convert to an ARM with a lower interest rate or more protective features (such as a better rate and payment caps) than the ARM they currently have.
- Want to build up equity more quickly by converting to a loan with a shorter term.
- Want to draw on the equity built up in their house to get cash for a major purchase or for their children’s education.
If you decide that refinancing is not worth the costs, ask your lender whether you may be able to obtain all or some of the new terms you want by agreeing to a modification of your existing loan instead of a refinancing.
Should You Refinance Your ARM?
In deciding whether to refinance an ARM you should consider these questions:
- Is the next interest rate adjustment on your existing loan likely to increase your monthly payments substantially?
- Will the new interest rate be two or three percentage points higher than the prevailing rates being offered for either fixed-rate loans or other ARMs?
- If the current mortgage sets a cap on your monthly payments, are those payments large enough to pay off your loan by the end of the original term?
- Will refinancing to a new ARM or a fixed-rate loan enable you to pay your loan in full by the end of the term?
What are closing costs?
“Closing costs” in a loan refer to the one time expenses associated with the work that is needed to close the loan. These “costs” can include origination fees and discount points, appraisal and credit report fees, title insurance, loan closing fees and endorsements for title, tax certificates and release/recording fees. If you are getting a “no-closing cost loan” that means that these fees may be credited to you by the lender or the rate you get will be slightly higher than if you were to be charged closing costs.
What are pre-paids?
Your recurring expenses or “pre-paid” expenses are those items that are associated with the ongoing maintenance of your mortgage loan. These are not considered costs! For example: interest is an ongoing, daily expense. The payoff amount on your old loan is affected by how many days have elapsed since your last payment. Your homeowners insurance is an annual expense, and your taxes are paid in Colorado 2 times per year; in February, and June.
A new escrow account?
When you refinance your loan, a new escrow account must be established and sufficient funds deposited in that escrow account to insure the availability of funds to pay your next tax and
insurance bill when they come due. The funds in your escrow account at your old lender are returned to you usually within 30 days of your loan being paid off. This is typically an amount less than the amount that is deposited with the new lender. These are not considered closing costs!
Who pays the “pre-paids”?
Recurring costs are always the responsibility of the borrower. Think about it like this: if you do not refinance, you will still have these ongoing expenses. These items, as well as your closing costs, can be added to your existing loan balance, as long as you stay within the loan-to-value limits of your loan program. Fannie Mae & Freddie Mac guidelines prohibit the payment of these items by a lender. Many clients choose to bring some or all of these funds to their closing, depending on the goals and objectives for the refinance.
Don’t be fooled by what some lenders call “No Cost Loans”!
If you are adding the closing costs of your loan to your existing loan balance, don’t confuse this type of transaction with a “no closing cost” refinance. Some lenders are a little fuzzy in their definition of a “no cost loan”. Make sure you understand the difference and that you know what type of refinance you are doing.
What Are the Costs of Refinancing?
The fees described below are the charges that you are most likely to encounter in a refinancing.
- Application Fee. This charge imposed by your lender covers the initial costs of processing your loan request and checking your credit report.
- Title Search and Title Insurance. This charge will cover the cost of examining the public record to confirm ownership of the real estate. It also covers the cost of a policy, usually issued by a title insurance company that insures the policy holder in a specific amount for any loss caused by discrepancies in the title to the property. Be sure to ask the company carrying the present policy if it can re-issue your policy at a re-issue rate. You could save up to 70 percent of what it would cost you for a new policy.
Because costs may vary significantly from area to area and from lender to lender, the following are estimates only. Your actual closing costs may be higher or lower than the ranges indicated below.
* Lender’s Attorney’s Review Fees. The lender will usually charge you for fees paid to the lawyer or company that conducts the closing for the lender. Settlements are conducted by lending institutions, title insurance companies, escrow companies, real estate brokers, and attorneys for the buyer and seller. In most situations, the person conducting the settlement is providing a service to the lender. You may also be required to pay for other legal services relating to your loan which are provided to the lender. You may want to retain your own attorney to represent you at all stages of the transaction including settlement.
* Loan Origination Fees and Points. The origination fee is charged for the lenders work in evaluating and preparing your mortgage loan. Points are prepaid finance charges imposed by the lender at closing to increase the lender’s yield beyond the stated interest rate on the mortgage note. One point equals one percent of the loan amount. For example, one point on a $75,000 loan would be $750. In some cases, the points you pay can be financed by adding them to the loan amount. The total number of points a lender charges will depend on market conditions and the interest rate to be charged.
* Appraisal Fee. This fee pays for an appraisal which is a supportable and defensible estimate or opinion of the value of the property.
* Prepayment Penalty. A prepayment penalty on your present mortgage could be the greatest deterrent to refinancing. The practice of charging money for an early pay-off of the existing mortgage loan varies by state, type of lender, and type of loan. Prepayment penalties are forbidden on various loans including loans from federally chartered credit unions, FHA and VA loans, and some other home-purchase loans. The mortgage documents for your existing loan will state if there is a penalty for prepayment. In some loans, you may be charged interest for the full month in which you prepay your loan.
* Miscellaneous. Depending on the type of loan you have and other factors, another major expense you might face is the fee for a VA loan guarantee, FHA mortgage insurance, or private mortgage insurance. There are a few other closing costs in addition to these.
In conclusion, a homeowner should plan on paying an average of 3 to 6 percent of the outstanding principal in refinancing costs, plus any prepayment penalties and the costs of paying off any second mortgages that may exist.
One way of saving on some of these costs is to check first with the lender who holds your current mortgage. The lender may be willing to waive some of them, especially if the work relating to the mortgage closing is still current. This could include the fees for the title search, surveys, inspections, and so on.
