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Closing costs don't have to kill your refinancing plans

Posted by  on Jun 05, 2013
 

Refinancing your mortgage can be enticing, especially if current mortgage rates are significantly lower than the interest rate you are paying on your mortgage loan. Before you leap at the chance to refinance, though, you may want to consider making this big financial move in the context of your other financial goals. Determine why you want to refinance -- you want to lower your monthly payments or shorten the term of your loan -- and then estimate your new monthly payments and closing costs for the refinance. Closing costs vary by state and from one lender to another, so compare mortgage quotes from several lenders. Typically closing costs range from 1 to 2 percent of the loan amount; so if you own a $300,000 home and decide to refinance, your closing costs could be $3,000 to $6,000.

There are a variety of ways you can pay closing costs on a refinance, each of which you should consider in the context of your financial plan.

Three ways to pay for a refinance

1.Cash. If you have the cash on hand and your goal is to reduce your mortgage payments and interest payments as much as possible, you may want to pay cash for your refinance costs. In fact, some homeowners bring extra money to their settlement to reduce their mortgage balance. The disadvantage of paying cash is that, once you've spent your savings, the money won't be available to pay for other needs or to invest for retirement. You should have an emergency fund, have reduced or eliminated credit card debt and be saving for retirement before you dip into your savings to pay for your refinance.

2.Wrap costs into your loan balance. Many borrowers opt to increase the size of their balance with the closing costs and assume they will recoup the money within a few months or a year or two, after which they will really begin saving on their mortgage payments. While this decision allows you to keep your cash in the bank, it will increase the size of your monthly payments for the life of the new loan. In addition, if your debt-to-income ratio is tight or you have very low equity in your home, you may not be able to qualify for the larger loan amount.

3.Pay a higher interest rate. A "zero-cost" refinance simply means that your lender will charge you a slightly higher interest (often .25 or .50 percent higher than the lowest mortgage interest rate) for the life of your loan in exchange for paying your closing costs. You will end up paying more in interest on a monthly basis and for your entire loan term, but you also have the benefit of keeping your cash in the bank.

A good lender can compare all three options with you and help you decide which refinance payment makes the most sense for you.

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