Refinancing your mortgage could save you thousands of dollars. However, refinancing has closing costs, just like new home loans.
Let’s take a look at whether you should refinance and how much it may cost.
Why Refinance a Mortgage?
There are several reasons you may choose to refinance your mortgage. For example, you may be able to find a lower interest rate and monthly mortgage payment, switch to a longer mortgage term, or cash out your existing loan.
There are other reasons, too. Some choose to refinance from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.
Cash-Out vs. HELOC
A cash-out refinance and a home equity line of credit (HELOC) are two ways to potentially gain access to cash.
Cash-Out Refinance
With a cash-out refinance, you take on a new mortgage loan. The appeal is that the new loan can be for an amount greater than what you currently owe on the house. At the same time, you may be able to secure a lower rate.
For example, if your loan balance is $150,000 on the house at 4.8%, you may be able to cash out for a $200,000 loan at 3.9%. This could save you money in the long run while giving you access to cash.
HELOC
A HELOC works a little differently. In this case, you are borrowing against the value of your home. This is often called your “equity.” If you have paid $50,000 toward your mortgage, you can borrow against that $50,000.
However, you typically cannot borrow the full amount of equity in your home. It is usually limited to 80% to 90%.
Notice that with a HELOC and a cash-out refinance, you are actually still borrowing money in either case. The difference is that with a HELOC, you borrow against your home’s equity.
With a cash-out refinance, on the other hand, you take on a new mortgage for a larger loan amount. But remember that you may be able to secure a lower interest rate which could make it a better deal.
ARM vs. Fixed-Rate Mortgage
ARMs can seem attractive because the interest rate may start lower. However, the interest rate will eventually increase. This makes them less affordable over time.
Fixed-rate mortgages will always have the same interest rate. Not only does this make them more affordable, but it also makes them more consistent. Because the rate is always the same, you will never be unsure how much you owe for any given month.
Refinancing an ARM mortgage to a fixed-rate is a common reason for a mortgage refinance.
Refinancing a Home for a Lower Interest Rate
In terms of overall cost savings, refinancing your mortgage for a lower rate will make the biggest impact. It can often lower your monthly mortgage payments dramatically.
To give a very simple example, suppose you buy a home for $200,000 on a 30-year fixed term at 6% interest. In this example, the total amount paid is $431,676 or $231,676 in interest.
But shaving just 1% off that interest rate takes the total cost down to $386,512, which is a difference of $45,164. With that amount of money, you could buy two brand-new cars, or several used cars.
However, you also have to be certain refinancing is worth it for you. Because there are so many variables, nothing is guaranteed.
Average Closing Costs
Let’s take a look at some closing costs associated with refinancing a mortgage. Per the Federal Reserve, here are some of the most common fees:
- Application fee: $75 to $300
- Loan origination fee: 0% to 1.5% of loan principal
- Points: 0% to 3% of loan principal
- Appraisal fee: $300 to $700
- Inspection fee: $175 to $350
- Attorney review/closing: $500 to $1,000
- Homeowner’s insurance: $300 to $1,000 (if not currently insured)
- FHA, RDS, VA fees, or private mortgage insurance (PMI): FHA = 1.5% plus 1/2% per year; RDS = 1.75%; VA = 1.25% to 2%; PMI = 0.5% to 1.5%
- Title search and title insurance: $700 to $900
- Survey fee: $150 to $400
- Prepayment penalty: one month to six months of interest payments
As you can see, not only is this a huge number of fees, it also allows for a huge amount of variability. As a result, it’s important to do your homework to determine whether refinancing is worth it.
Note that the mortgage refinance closing costs above are much the same as those you paid when you originally purchased the house. Because these fees can vary so much, the best way to estimate the cost is to look at the averages.
Mortgage Application Fee
This fee is fairly straightforward. It is simply the cost to apply for the mortgage loan (since refinancing will mean signing on to a new loan).
One thing to keep in mind here is the application will result in a credit inquiry. These will cause your credit score to dip a few points temporarily.
That is to be expected since a mortgage is a type of credit, but it’s something to keep in mind.
Loan Origination Fee
This is the fee levied by the broker or lender to secure the loan. This fee will only be charged if you decide to move forward with refinancing. Note that it is possible to reduce your origination fee.
Mortgage Points
Mortgage points can seem confusing, but they are actually fairly straightforward. The CFPB says the following about points:
Points, also known as discount points, lower your interest rate in exchange for paying for an upfront fee. Lender credits lower your closing costs in exchange for accepting a higher interest rate.
This means there will be some sort of calculation involved. Thus, you may want to use a mortgage points calculator to determine whether the offer is worth it.
Mortgage Appraisal Fee
Another fairly straightforward fee, this is the fee to have the house appraised. The lender must ensure that they aren’t issuing a loan for more than the house is worth.
They will likely also check the condition of the home, look for structural issues, and other potential problems.
Closing Costs Vary by State
To further complicate things, closing costs vary by state. This makes sense since every state has its own laws and vastly different property values. However, it does make things more complicated for the buyer.
Luckily, Bankrate has a great list of closing costs by state.
In most states, a $200,000 mortgage will have closing costs in the range of $1,7000 to $2,5000. However, you should check your state for a more accurate rate.
Closing Costs Vary by Lender
In addition to being different in every state, closing costs will, of course, be different for every lender as well.
As noted above in the page from the Federal Reserve, shopping around can have its advantages. What this means is that you would meet with different mortgage refinance lenders in your area for a quote.
Not only could this allow you to find a better interest rate, it could also give you leverage. If your current lender thinks you will take your business elsewhere, they may consider negotiating your current mortgage.
The more you shop around, the better chance you have of finding the best rate.
Credit Score Accuracy
Make sure your credit report is accurate before refinancing. Any inaccuracies, especially negative ones, could have a big impact on your interest rates.
There are some sites that may give you an estimation of your credit score, but you shouldn’t use those for something this important.
Instead, you’ll want to get them directly from the sources: TransUnion, Experian, and Equifax. You can request a report once per your from annualcreditreport.com.
If you find anything on your credit report that appears inaccurate, you should dispute it as soon as possible. Some items, such as derogatory marks, can make a big impact, so it’s critical to address them.
Cost of Refinancing Varies — a Lot
There are many costs associated with refinancing a mortgage. The cost to refinance your mortgage can vary by state, lender, and based on your individual circumstances.
The best way to accurately determine your refinancing costs is to meet with different lenders for quotes. You will not be committing to anything at that point. And because every lender is different, they could have very different quotes.
Deciding whether to refinance is a personal decision, but you want to be certain you get the best deal possible.
