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The true cost of no-cost refinance

Posted by  on Jan 24, 2013
 

While closing costs and other fees vary from one location to another, you should expect to pay at least two percent of your mortgage balance in refinancing fees. Even if current mortgage rates are low enough to entice you to refinance, you should do some careful calculations to determine whether the cost of a home refinance outweighs its benefits.

Determine your refinancing goals

Before you make any calculations, however, you should think about why you want to refinance. If you're just chasing interest rates competing with your friends to see who can get the lowest mortgage rate, you may want to take a step back and look at the cost of refinancing and the impact on your overall financial health. This is particularly true if you continually refinance into a 30-year fixed-rate loan, because you could end up paying more in interest than you think over the entire term of your borrowing.

If your goal is to pay off your loan balance faster, you may want to shorten your loan term. Remember that if you wrap your refinance costs into your balance, though, you're paying off a larger amount over time.

If you want to improve your cash flow by reducing your monthly mortgage payments, you may want to avoid wrapping your refinance costs into your loan because this could negate the benefits of refinancing.

Can you qualify?

Once you've identified your refinance goals, you need to evaluate your options for a mortgage refinance. A lender can work with you on an individualized basis, but in general, you'll need at least five percent and sometimes more in home equity, along with a credit score of at least 640 (but often higher) and a debt-to-income ratio of 41 percent or less in order to qualify for a new loan.

Three ways to pay for a refinance

  1. Cash. If you have the money on hand, you can avoid adding to your mortgage balance and avoid paying interest that would accrue if you wrap your costs into a new loan.
  2. Add your costs to your loan balance. Compare your monthly payments with the extra principal you'll be paying if you choose this method of refinancing. If your goal is lower payments, you'll still achieve that with a lower interest rate, but you should realize you'll be paying more interest over the life of the loan.
  3. Pay a higher interest rate. Many lenders also offer the option of "lender-paid" refinancing, which essentially means you'll pay an interest rate one-fourth to one-half of one percent higher than you would otherwise. You'll pay more in interest each month and over the life of the loan, but, on the other hand, you won't be increasing your loan balance or draining your savings account of needed cash.

When you meet with a lender to talk about refinancing, look at each of these scenarios to see which one meets your financial goals.

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