How to tell if refinancing's a
Since January, homeowners by the
busloads have taken advantage of some of the lowest
interest rates in years to refinance their homes.
Their shrewd refinancing deals may
make them the buzz of the local cocktail party circuit,
but rarely will they tell you how much they paid to get
that dazzlingly low interest rate of 6.5% on a 30-year
fixed. In just about every case, they paid plenty.
Borrowers who focus only on the
interest rate can easily be snookered, experts say. They
also should look at the transaction costs, which can be
Points are fees charged by lenders
when the mortgage deal closes. Each point equals 1% of the
amount borrowed, and they are typically the largest
transaction cost. Lenders allow refinancing customers a
choice: minimize transaction costs and pay a higher
interest rate, or maximize transaction costs and pay a
lower interest rate. A good credit risk willing to pay 3
or 4 points will end up with an astonishingly good
interest rate, but the high cost may not be worth it.
Take a borrower of a $200,000
mortgage who pays $8,000 in points to reduce the interest
rate on a 30-year mortgage from 7.25% to 6.5%. The lower
rate saves $100 a month. It would take nearly 7 years to
recoup the money spent to buy down that rate.
Mark Smokowicz, 47, of Saline,
Mich., figured out the trade-offs early. He's been
shopping to replace his 1-year adjustable-rate mortgage,
now at 8.9%. He is looking to refinance $180,000 at a
30-year fixed rate.
"When I began a month ago, I
was looking solely at the low interest rate, but the
closing costs were enormous," says Smokowicz, a
Smokowicz says the best interest
rates he's seen carry closing costs of more than $10,000.
He says he's decided to limit his closing costs, points
and other charges, to about $6,000, or 3.3% of the loan
amount, even though it'll bump his interest rate up by a
fraction of a percentage point.
Making the decision
So how do you decide? Experts say
refinancing shoppers have to determine first how long they
plan to stay in their current home, and whether their
expected tenure justifies going to the expense and
inconvenience of refinancing. Homeowners within a few
years of paying off their current mortgage also have to
decide whether the transaction costs are worth it.
The Internet provides enormous help
in calculating how long it would take for lower monthly
house payments to offset the refinancing costs. Among the
sites with handy calculators are www.domania.com,
www.homepath.com and quickenloans.quicken.com.
In addition to projecting the time
needed to recoup costs, borrowers should also consider the
hassle just to save a few bucks a month, says Keith
Gumbinger of mortgage tracker HSH Associates.
He warns borrowers to be careful of
deals advertised as low-cost or no-cost refinancings.
Customers will still be paying transaction costs through a
higher interest rate, a higher refinanced loan balance or
through a combination. Says Gumbinger: "It's not
free; it's just that there's nothing out-of-pocket
Refinancing expenses are largely
invisible because they're commonly just rolled into the
balance of the new mortgage. But the government requires
lenders not once but twice to lay out costs in writing.
The first required disclosure comes
at the time of application and represents the lender's
good faith estimate of closing costs. Receipt of the good
faith estimate is a good time to clear up any
misunderstandings or bail out of the deal. A more precise
accounting of costs on a government-approved form is
presented at closing. Even then, the law provides the
borrower a few days to bail out of the deal before it's
Here are some of the charges that
will be laid out in the written disclosures.
• Points. In many parts of
the country, lenders distinguish between origination
points — money to cover the lenders' costs — and
discount points — money to reduce the interest rate. For
the borrower, that distinction isn't important except that
some loans advertised as "zero points" may be
referring only to discount points, not origination points.
Mortgages typically come with zero
to 4 points. According to HSH, use of points has been on
the decline, and the average mortgage these days carries
less than 1 point. In general, a point paid at settlement
will reduce the interest rate of the mortgage from
one-eighth to one-quarter percentage point.
Regardless of how your lender
labels your points — origination or discount — the
Internal Revenue Service views them the same for
deductibility on income taxes, says Mildred Carter of CCH,
publisher of tax information. Their tax treatment gets
tricky, but generally speaking, taxpayers can't deduct the
full amount of points in a refinancing in the year they're
• Re-appraisal. In most
cases, the lender will require a professional appraiser to
calculate the market value of your home on the basis of
recent sales in the neighborhood. Expect to pay about
You may be able to sidestep this
cost if the appraisal for your existing mortgage is only a
few months old, or if you're refinancing only the balance
of your existing mortgage, and not tapping any additional
• Title insurance. Lenders
require insurance against the possibility that a borrower
may not have clear title to the property. The insurance
pays off, for example, if an unknown creditor makes claim
to the house to satisfy an old debt. It's expensive.
According to a recent industry
study, the median charge for a title company to issue
insurance and to oversee the closing of a mortgage deal is
82 cents per $100 of the loan amount, or $1,640 on a
$200,000 mortgage. In many instances, the cost of insuring
a title is discounted in a refinancing because ownership
is not changing hands. The amount of discount depends on
the state law and the length of time since the borrower
last bought title insurance.
• Prepaid escrow. This may
appear to add thousands to the bottom line of the
transaction, but it really doesn't. Your new mortgage
company wants to be in the position to use your money to
pay property taxes and hazard insurance premiums when they
come due. You should have a balance of comparable size in
the escrow account maintained by your old mortgage
company. So you'll pay for a new escrow account at
settlement, but you'll get a refund of the unspent balance
from your old company. It's a wash.
Likewise, expect to pay a month's
interest at closing. That money will be divided between
your old and new lenders to square you up for the month in
which you're closing. But don't count it as a closing cost
because the interest payment at closing substitutes for a
monthly mortgage payment that you won't have to make
because you're refinancing.