It’s no secret that now is a great time for many homeowners to refinance. Whether you’re looking for a lower monthly payment or need to cash out to pay bills or make renovations, it’s the right time to explore whether it makes financial sense for you to take advantage of lower rates.
But some of the details can be confusing, so we’ve decided to explain what they mean to help you make an informed decision. And if you are ready to start crunching numbers, make sure to check out Neat Capital’s Refinance Calculator, which will help you understand the costs involved and potential benefit.
What will refinancing cost me?
When refinancing, there are two main categories of costs, those controlled by the lender, and those controlled by third parties (appraisers, attorney’s, title companies). Lender related costs are fairly consistent and average between $700 – $1,800. Third-party costs will largely depend on the municipality, county and state in which the property is located, so it’s important to understand that depending on your property’s location will influence closing costs.
For the majority of states, when refinancing a loan amount of $300,000, for example, you should expect to pay between $2,200 – $3,500 in total closing costs.
But I saw an ad for a “No Closing Cost” refinance?
If you don’t have the cash to finance your closing, there are ways the refinancing can be structured to not have to pay those costs out of pocket. But like anything else in life, there are unfortunately no free lunches. Of course, lenders will advertise “No Closing Cost Refinances.” But for lenders to be able to finance your costs, they will generally charge you a higher rate, and take the additional revenue that they earn above what they need to produce the loan and deliver that amount back to you at the closing table in the form of a lender credit, which ultimately works to offset the fees necessary to close the loan. The result is that you come to closing with no money, but leave with a higher rate than you would have achieved if in fact you were to pay the costs out of pocket, or lumped those costs into the new loan amount.
So how do I decide?
Assuming a hypothetical loan amount of $300,000, you have three options to consider when deciding which strategy makes the most sense for your personal situation:.
- Bring $3,000 to the closing table
- Increase your loan amount by $3,000
- Increase your rate enough to create a lender credit of $3,000
Determining which option is best for you is important and there are certain things you should consider as you are evaluating these options. The first thing you’ll want to understand is whether you have the $3,000 saved and are you comfortable bringing that amount to closing. If you don’t, you’ll be forced to decide between options 2 and 3.
Although most borrowers tend to select option 2 and lump the costs into the loan so that they can receive the lowest possible rate, it’s not always the best strategic option.
By way of example, let’s say that you plan to live in the home for another 2 years and the interest rates you are being quoted for option’s 2 and 3 are 4.00% and 4.25% respectively. If you select option 2 with the lower rate, your loan amount will increase by $3,000, however, you will only save approximately $1,500 in interest over the 2-year period that you stay in the home. In this scenario you would have walked away from $1,500. So keep an eye on what it means for short-term gain over long-term savings.
If you chose option 3, your loan amount would not increase, but you would have selected the higher rate with no closing costs. Over the 2-year period you can expect to pay approximately $1,500 of additional mortgage interest, but because you didn’t increase your loan amount up front, the true cost of the refinance would be limited to $1,500 of excess interest paid over the 2-year period.
If you are staying in the home long term (5-10+ years), option 1 is almost always your optimal choice, option 2 would often be your second best choice, and option 3 should be your last resort.
That makes sense, I think I’m ready to move forward
Determining whether the total costs to refinance makes sense heavily depends on how long you plan to keep the loan. The time in which it takes to recapture the cost you spend to refinance is called the “break even” period. If the ultimate goal of a refinance is to save money, you’ll want to determine that your long-term savings exceeds the costs to secure the refinance. Knowing that it can be complex to calculate, Neat Capital created a helpful calculator to help you understand how long it will take you to recover the costs that you would incur to refinance and how much you will ultimately save over the period of time in which you remain in the home. You can explore it here.