Refinancing & Other Issues

The Costs of Refinancing

The Costs of Refinancing

Let’s run down a list of the typical fees. We have provided you with a worksheet to fill in the information you get from lenders.

Costs of Refinancing Worksheet

Fill in This Worksheet When You Call Lenders

The Break-Even Point

Now that you have an idea about the costs associated with refinancing, you need to determine if it will wind up saving you money in the long run. If current rates aren’t that much lower than your existing rate, but you plan to stay in your house, you may still save money by refinancing.

Examine the calculation below which computes the amount of time it will take to recover the cost of refinancing, i.e., break-even point.

CAUTION!: If your break-even point exceeds the length of time you intend to stay in your home, don’t refinance! For example, if it will take 29 months to recover your refinancing costs and you plan to be in your home for 22 months, it will not pay to refinance.

Break-Even Point - Example

What does this mean? If the homeowners in the example plan on staying in their home for 30 months or more, they will save money by refinancing. They will have gotten back the $3,000 it cost for the refinance in the 29th month. However, this analysis doesn’t take into

consideration the time value of money. If the time value of money is factored in, the break-even point will be slightly longer.

The Point of Points

Let’s begin by looking at something you always hear about when you talk mortgage basics... points.

Lenders make money on mortgage loans in two ways: By charging you interest, which you pay each month when you send in your payment, and by charging you a ‘loan fee’, commonly called points, that are paid when you take out the mortgage loan.

Some loans are ‘no point’ loans which means that no money is collected up front. While this helps you with the cash that you need when buying the home, the trade off is that the amount of interest you pay each month will be higher. There are also some unique tax treatments in conjunction with points paid on a refinance as opposed to points paid on obtaining an original loan -- more on this later.

Sounds simple enough, but what does it mean to you? How do you choose between two different loans and decide which loan is cheaper for you?

One easy measure is to compare each loan’s annual percentage rate (APR). Each lender is required by law to provide you with this information. When trying to decide between two loans, generally the one with the lower APR will be the cheapest.

The problem is that the APR is computed as if you held the mortgage until you completely paid it off. What if you only intend to stay in this home or keep the mortgage for five or six years?

You’ll need to look at the effective annual interest rate (see below.)

HOT TIP!: Assuming equivalent APR’s on two mortgages, one with points and one without, the rule of thumb is that the no point mortgage will be cheaper unless you plan on holding your mortgage loan at least 9 or 10 years.

Rate Versus Point Comparison

Here is an example of the rate versus point comparison calculation. The loan with the lower effective rate wins.

Rate Versus Point Comparison

The effective annual interest rate represents the true annual cost of the loan over the period of time you intend to keep the loan. The effect of paying more points will diminish the longer you intend to hold the loan. Although this calculation will help you determine your best choice, it does not take into consideration the time value of money. If the time value of money is factored in, the effective annual interest rate would rise slightly as you pay more points.

HOT TIP!: Shop for the best deal. Getting a good interest rate with a minimum of closing costs is your first objective. Choose the loan with the lowest overall cost of borrowing. Select a loan structure that achieves your financing goal. Ask potential lenders to give you a "Good Faith Estimate" which will outline all of the costs associated with that lender's particular loan offering. You can then compare "Good Faith Estimates" from various lenders to be able to choose the best deal.

HOT TIP!: Mortgage lenders are in a position to help explain the various features and benefits of the lending programs they offer. Don’t be afraid to ask for help in understanding the many options.