By refinancing your mortgage to a loan with a lower interest rate, you can save hundreds of dollars a month on your home loan payments. But refinancing isn't free. You'll have to pay certain costs, either upfront in a lump-sum payment or by rolling them into your monthly payments, to close a refinance.
You can expect to pay from 3 percent to 6 percent of your mortgage loan's outstanding principal in lenders and closing fees when you refinance. If you owe $200,000 in principal, that comes to $6,000 to $12,000. You can pay this amount in a lump sum, or you can roll it into your monthly mortgage payments. The second option will boost your monthly mortgage payments slightly, but it will also save you the challenge of having to come up with such a large amount of cash.
What You Pay For
Your refinance fee covers a wide variety of services that your lender and third-party companies provide to close your refinanced loan. Your lender might charge an application fee and charge you for the costs of running your credit score. You might also have to pay for an appraiser to determine the current market value of your home and a title insurance company to ensure you are the rightful owner of your home and there are no outstanding liens against it. You might pay the costs of having an attorney look over the refinance paperwork.
Are the Fees Worth It?
Because refinancing isn't free, you need to determine that your monthly cost savings are high enough to cover the fees associated with moving to a lower interest rate. If you owe $250,000 in principal on your home and you have a 30-year fixed-rate loan at 6 percent interest, you'll save more than $376 a month by refinancing to a 30-year fixed-rate loan with an interest rate of 3.5 percent. That comes out to a savings of $4,512 a year. But if you owe $250,000 on the same loan but are refinancing from an interest rate of 4.2 percent to one of 3.5 percent, you'll save about $99 a month, or less than $1,200 a year. That might not justify the costs of refinancing.
How Long Will You Stay?
Another factor that determines whether the upfront costs of refinancing are justified is the length of time you plan to spend in your home. If you are saving $2,500 a year and you plan on staying in your home for 20 years, your refinance will save you $50,000. If you plan on moving in five years, you'll save $12,500. Again, that might not be enough to justify the costs and time involved in refinancing.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.