Refinancing Your Home
How much will it cost to refinance
your mortgage?
When you refinance your mortgage, you usually pay off your original
mortgage and sign a new loan. With a new loan, you again pay most
of the same costs you paid to get your original mortgage. These
can include settlement costs, discount points, and other fees.
You also may be charged a penalty for paying off your original
loan early, although some states prohibit this.
The total expense for refinancing a mortgage depends on the interest
rate, number of points, and other costs required to obtain a loan.
To obtain the lowest rate offered by the lender, most lenders
will charge several points, and the total cost can run between
three and six percent of the total amount you borrow. So, for
example, on a $100,000 mortgage, the lender might charge you between
$3,000 and $6,000. However, some lenders may offer zero points
at a higher interest rate, which may significantly reduce your
initial costs, although your payments may be somewhat higher.
Is the interest rate low enough
to save you money?
Talk to some lenders to determine the available rates and the
costs associated with refinancing. These costs include appraisals,
attorney's fees, and points. Then determine what your new payment
would be if you refinanced. You can estimate how long it will
take to recover the costs of refinancing by dividing your closing
costs by the difference between your new and old payments (your
monthly savings). However, the ultimate amount you may save depends
on many factors, including your total refinancing costs, whether
you sell your home in the near future, and the effects of refinancing
on your taxes.
The old rule of thumb used to be that you shouldn't refinance
unless the new interest rate is at least two percentage points
lower. However, many lenders are now offering zero point loans
and low-cost refinancing. Therefore, even if your rate change
is less than one percentage point, you may be able to save some
money by refinancing.
How many "points" must
you pay to the lender to obtain the loan?
In refinancing, lenders usually offer a range of interest rates
at different amounts of points. A point equals one percent of
the loan amount. For example, three points on a $100,000 mortgage
loan would add $3,000 to the refinancing charges.
Shopping for points as well as interest rates may save you money.
As a rule of thumb, each point adds about one-eighth to one-quarter
of one percent to the interest rate the lender is offering.
Generally, the lower the interest rate on the loan, the more points
the lending institution will charge. Some lenders offer refinancing
with no points, but generally charge higher interest rates.
To decide what combination of rate and points is best for you,
balance the amount you can pay up front with the amount you can
pay monthly. The less time that you keep the loan, the more expensive
points become. If you plan to stay in your house for a long time,
then it may be worthwhile to pay additional points to obtain a
lower interest rate.
Some lenders may offer to finance the points so that you do not
have to pay them up front. This means that the points will be
added to your loan balance, and you will pay a finance charge
on them. Although this may enable you to get the financing, it
also will increase the amount of your monthly payments.
What other settlement costs will
the lender require you to pay at closing?
Settlement costs typically include fees for the loan application,
title search, appraisal, loan origination, credit check, and lawyer's
services. You also may be required to pay recordation fees or
transfer taxes. If you are shopping for a lender, ask each one
for a list of charges and costs you must pay at closing. Some
lenders may require that some of these costs be paid at the time
of application.
How would refinancing affect the
taxes you owe?
With a lower interest rate on your home loan, you will have less
interest to deduct on your income tax return. That, of course,
may increase your tax payments and decrease the total savings
you might obtain from a new, lower-interest mortgage.
You should be aware of an Internal Revenue Service (IRS) ruling
with respect to points paid solely for refinancing your home mortgage.
IRS regulations require that interest (points) paid up front for
refinancing must be deducted over the life of the loan -- not
in the year you refinance -- unless the loan is for home improvements.
This means that if you paid a certain number of points, you would
have to spread the tax deduction for those points over the life
of the loan. If, however, the refinancing is for home improvements
-- or a portion of the loan is for this purpose -- you may be
able to deduct the points -- or a portion of the points -- under
certain circumstances. Check with the IRS regarding the current
rulings on refinancing, particularly if you are using the new
loan to make home improvements.
Should you also consider a different
type of mortgage?
If you are thinking about refinancing your mortgage, you might
want to consider other types of mortgages. For example, you might
want to look into a 15-year, fixed-rate mortgage. In this plan,
your mortgage payments are somewhat higher than a longer-term
loan, but you pay substantially less interest over the life of
the loan and build equity more quickly. (Of course, this also
means you have less interest to deduct on your income tax return.)
You also might want to consider refinancing if you have an adjustable
rate mortgage with high or no limits on interest rate increases.
You might want to switch to a fixed-rate mortgage or to an adjustable
rate mortgage that limits changes in the rate at each adjustment
date as well as over the life of the loan.
If you decide to apply for refinancing with a particular lender,
and if you do not want to let the interest rate "float"
until closing, get a written statement guaranteeing the interest
rate and the number of discount points that you will pay at closing.
This binding commitment or "lock-in" ensures that the
lender will not raise these costs even if rates increase before
you settle on the new loan. You also may consider requesting an
agreement where the interest rate can decrease but not increase
before closing. If you cannot get the lender to put this information
in writing, you may wish to choose one who will.
Most lenders place a limit on the length of time (say, 60 days)
they will guarantee the interest rate. You must sign the loan
during that time or lose the benefit of that particular rate.
Because many people are refinancing their mortgages, there may
be a delay in processing the papers. Therefore, you may want to
contact your loan officer periodically to check on the progress
of your loan approval and to see if additional information is
needed.
What do you look for when shopping
for a home mortgage?
If you decide to refinance your mortgage, shopping around by calling
several lending institutions to ask each one what interest and
fees they charge will help you get the best deal available. Also
ask each about their "annual percentage rate" (APR)
and compare them. The APR will tell you the total credit costs
of the refinancing, including interest, points, and other charges.
Remember, you do not have to refinance your mortgage with the
same lender that provided your original mortgage. However, to
keep your business, some lenders will offer their original mortgage
customers the incentive of lower mortgage interest rates, sometimes
with reduced closing costs.
What disclosure must the lender
give you?
For a refinancing, the lender must give you a written statement
of the costs and terms of the financing before you become legally
obligated for the loan, as required by the Truth in Lending Act.
You usually will receive the information around the time of settlement,
although some lenders provide it earlier. You will want to review
this statement carefully before you sign the loan. The disclosure
tells you the APR, finance charge, amount financed, payment schedule,
and other important credit terms. If you refinance with a different
lender, or if you borrow beyond your unpaid balance with your
current lender, you also must be given the right to rescind the
loan. In these loans, you have the right to rescind or cancel
the transaction within three business days following settlement,
receipt of your Truth in Lending disclosures, or receipt of your
cancellation notice, whichever occurs last.
Will the lender refund your application fees if you do not sign
the mortgage?
When you apply for a mortgage, some lenders require you to pay
a special charge to cover the costs of processing your application.
The amount of this fee varies, but it may be $100 to $200. Usually,
you must pay this charge at the time you file the application.
Some lenders do not refund this application fee if you are not
approved for the loan or if you decide not to take it. So, before
you apply for a mortgage, ask lenders whether they charge an application
fee. If they do, find out how much it is and under what circumstances
and to what extent it is refundable. However, if you elect to
cancel the transaction within three business days after you close
the loan, as discussed above, you are entitled to a refund of
all costs and charges imposed for the credit transaction.
