The total expense for refinancing a mortgage depends on the interest
rate, number of points, and other costs required to obtain a loan. To
obtain the lowest rate offered by the lender, most lenders will charge
several points, and the total cost can run between three and six percent
of the total amount you borrow. So, for example, on a $100,000 mortgage,
the lender might charge you between $3,000 and $6,000. However, some
lenders may offer zero points at a higher interest rate, which may
significantly reduce your initial costs, although your payments may be
somewhat higher.
Is the interest
rate low enough to save you money?
Talk to some lenders to determine the
available rates and the costs associated with refinancing. These costs
include appraisals, attorney's fees, and points. Then determine what
your new payment would be if you refinanced. You can estimate how long
it will take to recover the costs of refinancing by dividing your
closing costs by the difference between your new and old payments (your
monthly savings). However, the ultimate amount you may save depends on
many factors, including your total refinancing costs, whether you sell
your home in the near future, and the effects of refinancing on your
taxes.
The old rule of thumb used to be that you shouldn't refinance unless the
new interest rate is at least two percentage points lower. However, many
lenders are now offering zero point loans and low-cost refinancing.
Therefore, even if your rate change is less than one percentage point,
you may be able to save some money by refinancing.
How many "points" must you pay to the lender to obtain the loan?
In mortgage refinancing, lenders
usually offer a range of interest rates at different amounts of points.
A point equals one percent of the loan amount. For example, three points
on a $100,000 mortgage loan would add $3,000 to the refinancing charges.
Shopping for points as well as interest rates may save you money. As a
rule of thumb, each point adds about one-eighth to one-quarter of one
percent to the interest rate the lender is offering.
Generally, the lower the interest rate on the loan, the more points the
lending institution will charge. Some lenders offer refinancing with no
points, but generally charge higher interest rates.
To decide what combination of rate and points is best for you, balance
the amount you can pay up front with the amount you can pay monthly. The
less time that you keep the loan, the more expensive points become. If
you plan to stay in your house for a long time, then it may be
worthwhile to pay additional points to obtain a lower interest rate.
Some lenders may offer to finance the points so that you do not have to
pay them up front. This means that the points will be added to your loan
balance, and you will pay a finance charge on them. Although this may
enable you to get the financing, it also will increase the amount of
your monthly payments.
What other
settlement costs will the lender require you to pay at closing?
Settlement costs typically include fees
for the loan application, title search, appraisal, loan origination,
credit check, and lawyer's services. You also may be required to pay
recordation fees or transfer taxes. If you are shopping for a lender,
ask each one for a list of charges and costs you must pay at closing.
Some lenders may require that some of these costs be paid at the time of
application.
How would
refinancing affect the taxes you owe?
With a lower interest rate on
your home loan, you will have less interest to deduct on your income tax
return. That, of course, may increase your tax payments and decrease the
total savings you might obtain from a new, lower-interest mortgage.
You should be aware of an Internal Revenue Service (IRS) ruling with
respect to points paid solely for refinancing your home mortgage. IRS
regulations require that interest (points) paid up front for refinancing
must be deducted over the life of the loan -- not in the year you
refinance -- unless the loan is for home improvements. This means that
if you paid a certain number of points, you would have to spread the tax
deduction for those points over the life of the loan. If, however, the
refinancing is for home improvements -- or a portion of the loan is for
this purpose -- you may be able to deduct the points -- or a portion of
the points -- under certain circumstances. Check with the IRS regarding
the current rulings on refinancing, particularly if you are using the
new loan to make home improvements.
Should you also
consider a different type of mortgage?
If you are thinking about refinancing your mortgage, you might want to
consider other types of mortgages. For example, you might want to look
into a 15-year, fixed-rate mortgage. In this plan, your mortgage
payments are somewhat higher than a longer-term loan, but you pay
substantially less interest over the life of the loan and build equity
more quickly. (Of course, this also means you have less interest to
deduct on your income tax return.)
You also might want to consider refinancing if you have an adjustable
rate mortgage with high or no limits on interest rate increases. You
might want to switch to a fixed-rate mortgage or to an adjustable rate
mortgage that limits changes in the rate at each adjustment date as well
as over the life of the loan.
If you decide to apply for refinancing with a particular lender, and if
you do not want to let the interest rate "float" until closing, get a
written statement guaranteeing the interest rate and the number of
discount points that you will pay at closing. This binding commitment or
"lock-in" ensures that the lender will not raise these costs even if
rates increase before you settle on the new loan. You also may consider
requesting an agreement where the interest rate can decrease but not
increase before closing. If you cannot get the lender to put this
information in writing, you may wish to choose one who will.
Most lenders place a limit on the length of time (say, 60 days) they
will guarantee the interest rate. You must sign the loan during that
time or lose the benefit of that particular rate. Because many people
are refinancing their mortgages, there may be a delay in processing the
papers. Therefore, you may want to contact your loan officer
periodically to check on the progress of your loan approval and to see
if additional information is needed.
What do you look for
when shopping for a home mortgage?
If you decide to refinance your
mortgage, shopping around by calling several lending institutions to ask
each one what interest and fees they charge will help you get the best
deal available. Also ask each about their "annual percentage rate" (APR)
and compare them. The APR will tell you the total credit costs of the
refinancing, including interest, points, and other charges.
Remember, you do not have to refinance your mortgage with the same
lender that provided your original mortgage. However, to keep your
business, some lenders will offer their original mortgage customers the
incentive of lower mortgage interest rates, sometimes with reduced
closing costs.
What disclosure must
the lender give you?
For a mortgage refinancing, the
lender must give you a written statement of the costs and terms of the
financing before you become legally obligated for the loan, as required
by the Truth in Lending Act. You usually will receive the information
around the time of settlement, although some lenders provide it earlier.
You will want to review this statement carefully before you sign the
loan. The disclosure tells you the APR, finance charge, amount financed,
payment schedule, and other important credit terms. If you refinance
with a different lender, or if you borrow beyond your unpaid balance
with your current lender, you also must be given the right to rescind
the loan. In these loans, you have the right to rescind or cancel the
transaction within three business days following settlement, receipt of
your Truth in Lending disclosures, or receipt of your cancellation
notice, whichever occurs last.
Will the lender refund
your application fees if you do not sign the mortgage?
When you apply for a mortgage, some
lenders require you to pay a special charge to cover the costs of
processing your application. The amount of this fee varies, but it may
be $100 to $200. Usually, you must pay this charge at the time you file
the application.
Some lenders do not refund this application fee if you are not approved
for the loan or if you decide not to take it. So, before you apply for a
mortgage, ask lenders whether they charge an application fee. If they
do, find out how much it is and under what circumstances and to what
extent it is refundable. However, if you elect to cancel the transaction
within three business days after you close the loan, as discussed above,
you are entitled to a refund of all costs and charges imposed for the
credit transaction. |
