Home ownership is one of the goals most individuals, both young and old, strive to achieve. In healthy market environments, real estate appreciates in value creating a long-term asset that generates the potential for a substantial return over time. Fortunately, becoming a home owner does not have to be a difficult task in terms of financial ability, as a full cash payment is not a necessity thanks to financing through a mortgage. But when a mortgage is taken out on a home during a high interest rate market, or when credit is in less than ideal shape, the total cost of financing can be high.
To remedy an expensive mortgage due to a higher interest rate, home owners have the ability to refinance through a mortgage lender, bank or credit union. Refinancing allows the borrower to essentially create a new loan – preferably with better repayment terms and a lower applied interest rate – and pay off the initial mortgage. Refinancing can extend repayment for up to an additional 30 years, creating a less burdensome monthly payment. In some cases, a shorter repayment period can be elected (such as 15 years), to expedite full repayment of the loan on the home. In the best scenarios, a combination of a lower interest rate and a suitable repayment term helps home owners benefit in the long run from their residential property.
While refinancing a mortgage is appealing, especially while interest rates remain at historically low levels, the process is not free. Let’s examine what goes into the cost of refinancing a home before discussing if it is a viable solution.
Breaking Down Mortgage Refinancing Costs
The general school of thought that guides mortgage refinancing decisions is this: if you are able to reduce your interest rate by at least 1%, the refinance probably makes sound financial sense. However, there are a number of ancillary factors that have an impact on the overall refinance transaction. The following are costs commonly associated with refinancing a mortgage.
Mortgage application fee: most lenders assess a mortgage application fee for all refinance applications. This fee includes the cost for pulling a borrower’s credit report and other administrative expenses the lender passes down to the individual(s) applying for a new mortgage. On average, the mortgage application fee falls between $200 and $500.
Origination fee: assessed as a percentage of the total new mortgage amount, an origination fee is often one of the highest fees associated with any refinance transaction. Origination fees are typically 1%, and go toward paying the chosen lender directly.
Appraisal fee: All lenders requires homeowners to have an appraisal completed when a refinance application is submitted. An appraisal allows the lender to determine the market value of the home, and if the borrower has accumulated enough equity to justify the refinance or secure a lower interest rate. Appraisal fees range from $200 to $500 for most refinance applications.
Title fees: another factor in the cost of refinancing are title fees associated with generating a new mortgage. Lenders often require a title search to ensure there are no glaring issues with ownership or liens. Title insurance provides protection to both the homeowner and the lender in the case issues arise in the process. Title fees may also include miscellaneous charges, such as courier costs, express mail costs, and recording costs with the county. On average, title fees range from $400 up to $800 for most refinance transactions.
Insurance fees: all lenders require a homeowner to have an insurance policy in place at the time of the loan closing to protect the replacement cost should something happen to the home itself. In addition to typical homeowner’s insurance, lenders may require flood certification or special hazard insurance should the property be located in certain areas of the country. Insurance fees range depending on the property location.
Points: mortgage points fall into two categories – origination fees and discount fees. Lenders offer points to borrowers as a way to buy down the mortgage interest rate offered. Discount fees are prepaid interest that homeowners pay up front, while origination fees simply equate to compensation direct to the lender offering the loan. Regardless of type, one mortgage point is equal to 1% of the total loan amount.
The combination of these various fees add up quickly for homeowners looking to refinance their residential property. All in, refinancing fees total an average of 1.5% of the total amount of the loan, and are due at the time the loan is fully processed. In some instances, lenders allow the homeowner to roll closing costs associated with a refinance in to the new mortgage loan, saving them the out of pocket expense. However, adding a few thousand dollars to the total mortgage balance affects the monthly payment, and ultimately, the total cost paid for the mortgage over time.
Should I Refinance?
Although the rule of thumb relating to interest rate reduction is a great place to start the refinance discussion, the addition of closing costs inherent to the transaction should cause you to pause before pulling the trigger. Every homeowner has a different situation in terms of equity accumulated in the home, time to repay, and total cost of their current mortgage, making the decision to refinance unique to each individual. However, being aware of the out of pocket costs necessary to close on a new mortgage through the process of refinancing should paint a clear picture as to if the transaction is worth it, or not.
To safeguard yourself from making a poor financial decision when it comes to refinancing your home, start with a lender you trust. If you can’t seem to get a clear answer as to what the refinance will ultimately cost, or you have a strong gut feeling that you are paying too much, ask! Lenders are required to provide full disclosure of all fees associated with a refinance transaction, just as they are with a new mortgage. It is also in your best interest to shop around for various lenders when starting down the road toward refinancing. You may be surprised the difference in costs associated with closing on the new loan, as well as the interest rate and repayment terms available. Above all else, plan to crunch the numbers prior to charging ahead with a refinance to ensure it is the best financial decision for your circumstances.