Is It Worth Refinancing for a 1% Rate Reduction?
Is it worth refinancing your mortgage just to cut your interest rate by 1 percent? As long as you plan to stay in your home for at least five more years the answer is, easily, yes.
If you think you might be moving sooner, then you'll need to take a closer look at the closing costs and the interest you can save to figure out whether it's worth it. If you're in an adjustable rate mortgage, you also may want to consider locking in these historically low rates unless you plan to move in the next three or four years.
First, let's take a look at how much you can save monthly, annually and over the life of the loan. We'll use a $200,000 mortgage currently at a rate of 5.5 percent and assume you can lower that to 4.5 percent. We'll also assume you took the loan about two years ago, so you have 28 years left on the mortgage and the current principal balance is $194,215. Finally, we'll assume your closing costs for the refinance will be $5,795 that you roll into the new mortgage, so the new mortgage will be $200,000. Your closings costs could be higher or lower. We'll talk about closing costs and how to cut your costs when refinancing below.
The current payment on the $200,000 mortgage at 5.5 percent is $1,135.58 for principal and interest. The monthly payment after refinance will be $122.21 per month less at $1013.37 for principal and interest. That means you will have almost $1,500 more in your pocket each year that you can use in whatever way you'd like.
The cost of this refinance was just under $6,000, so in as little as four years you've saved the cost of the transaction. Now you have 26 years to enjoy the savings or you can use the savings to pay down the principal more quickly and save even more interest. If you make the choice to pay down the principal more quickly with your savings, you could cut about six years off the length of your mortgage and save about $60,000 in interest.
Over the life of the 5.5 percent mortgage you would pay $208,808 in interest. You've already paid $22,605 of that interest in the first two years, but still have $186,203 in interest to pay. Even though you'll be rolling in the closing costs you'll still save almost $22,000 in interest with the 4.5 percent mortgage. The total interest costs over that life of that mortgage is $164,813.
The key in a refinance is to find the lowest closing costs, as well as the lowest interest rate. Fees can add $3,000 to $6,000 to the costs of refinancing. For example, title search and title insurance fees can range from $450 to $1,500. You may be able to negotiate a lower fee if you work with the same title insurance company. The title insurance company may be willing to update your current policy for a much lower fee.
Other key fees you should pay close attention to and possibly negotiate include:
Application Fees These can range from $75 to $350 or more. You may be able to negotiate these downward, especially if your refinancing through the same lender.
Appraisal Fee These fees can range from $150 to $400. If you have enough equity in the home, sometimes your lender will be willing to work with an electronic appraisal rather than a full appraisal with someone coming to inspect the home. That can save you $100 or more.
Survey Costs These can run from $125 to $300. If you're working with the same lender he may be willing to waive these fees, since your lender already has a survey on the property from the first closing.
Lender's Attorney Review Fees These can range from $75 to $200 or more depending upon who conducts the closing for the lender. Since you're not involved in a real estate sales transaction, you may be able to save money by not insisting that an attorney close the loan, but be sure you're comfortable with reading the loan documents yourself.
Prepayment Penalty Be sure the loan you have does not include a prepayment penalty. Also, be sure the new loan you're taking doesn't have one. A prepayment penalty is a fee charged if you pay your mortgage off early.
Lender's Fees These are also known as "garbage fees" and can cost you between $650 and $800. They include fees for processing, underwriting, document preparation, as well as administrative and funding fees. You may also see fees such as tax service fees, wire, and flood certification fees. You will find them on all loans, but may be able to negotiate fees lower when you get lenders into a bidding war for your business.
Another key cost that can add thousands to a refinancing are loan origination fees and points. Generally you're best off looking for a loan with no points when refinancing. A point is equivalent to 1 percent of your loan principal. For example, for a $200,000 loan you'll pay $2,000 in cash up front for one point.
Carefully compare your fees when you look at different offers and be sure you are comparing apples to apples. For example, If your state charges significant taxes to record the new mortgage, some lenders may include this amount in their initial offer and others may not. So look carefully on a line-by-line basis at all lenders estimate of costs. Once you get the bids from other lenders, it can't hurt to make one more call to your own lender and see if they'll give you a better offer.
Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Improving Your Credit Score.