If you’ve thought about refinancing your home, you’re not alone. Refinances represent nearly 40% of all mortgages, according to a November Mortgage Bankers Association report.
Usually people refinance to get a lower interest rate, but there are other reasons as well, and while there are benefits to a refinance, they do come with numerous fees. You should evaluate those costs as you consider the pros and cons of refinancing.
Costs associated with refinancing a mortgage
When evaluating the total costs of a refinance, you will need to speak with your lender for specific fees, as fees vary by lender and your individual financial circumstances. These fees will be very similar to those you paid with the initial mortgage. In most cases, it’s common for total closing costs to equal approximately 2% to 3% of the total loan amount.
Here are the common costs of a mortgage refinance:
- Application fee: $75-$300
- Appraisal charges: $350-$800
- Origination fees: 1% to 1.5% of total principal
- Document preparation fees: $200-$500
- Title search and insurance fee: $700-$900
- Inspection charge: $300-$850
- Flood certification: $15-$25
- Recording fees: $25-$500
You should weigh the total closing costs against the amount you will save during the term of the loan to see if those savings are greater than the costs.
Reasons to refinance your mortgage
There is a variety of reasons you may want to refinance your mortgage, which may include the following:
To get cash from your home equity with a cash-out refinance
If you’ve got a significant amount of equity in your home, you may want to take out a loan for more than you owe in order to receive cash. You can then use that cash to pay for renovations on the property, college tuition, credit card debt or to purchase a car.
Before opting for a cash-out refinance, though, you should consider all your options to obtain extra cash: a home equity loan and home equity line of credit, both of which use the home as collateral, but may come with more favorable loan terms.
To lower your interest rate
Trading a higher interest rate for a lower rate is one of the most common reasons to refinance. “The main motivation is to get a lower interest rate, get a lower monthly payment and save on the total cost of the mortgage,” said Tendayi Kapfidze, chief economist at LendingTree, the parent company of MagnifyMoney.
To change your loan term
Often, homeowners refinance to either shorten or lengthen the time it takes to pay off their mortgage. For example, maybe 10 years after first getting a mortgage, your income increases substantially, meaning you can afford a higher monthly payment. You may want to refinance from a 30-year mortgage to a 15-year mortgage, which will save you on interest paid over the life of the loan. You’ll also build home equity at a faster pace.
On the other hand, you may find it difficult to make your monthly payment on a 15-year mortgage, so you may want to refinance to a 30-year mortgage to make payments more affordable.
To convert an ARM to a fixed-rate mortgage
With an adjustable rate mortgage, you get a mortgage with an initial interest rate that remains the same for a set period of time. However, after that interim passes, that rate can decrease or increase, meaning the monthly payment will change. You may opt for an ARM as a way to get a mortgage, and then refinance before the rates change in order to get a more favorable fixed rate.
To convert FHA to conventional
Many homeowners choose an FHA-insured mortgage because they can qualify with a lower down payment. However, one trade-off for that product is having to pay mortgage insurance for the life of the loan, which covers the loan should you default. You are free to refinance from an FHA loan to a conventional mortgage once you have 20% equity in your home. That means you could drop the insurance.
How to lower mortgage refinance costs
While you will have to pay closing costs when refinancing your mortgage, it’s possible to reduce those costs by following these three recommendations.
You’ll want to make sure you do your research to get the best deal. “Talk to many lenders because there’s quite a wide range of interest rates out there,” Kapfidze said.
However, shopping around is not something many homeowners do, Kapfidze noted. He cited a 2015 report from the Consumer Financial Protection Bureau that states that nearly half of all mortgage borrowers don’t shop around when searching for a mortgage lender.
Taking the time to talk to several lenders and find out what they have available for a refinance is the best way to ensure you’re getting the best loan for your needs.
When talking loan terms with lenders, don’t be afraid to ask if there is some wiggle room regarding the closing costs or interest rate of the mortgage. Depending on the loan and the current state of the mortgage market, there could be an opportunity to shave some of those numbers down.
“Right now, volumes are kind of low, so we see more competition,” Kapfidze said. “The more competition there is, lenders are more likely to be accommodating, so it’s always good to try to negotiate.”
Ask for a zero-closing-cost loan
Many lenders may offer a “zero-closing-cost” refinance mortgage. That means the lender will roll those costs into the loan principal, often in exchange for charging you a higher interest rate. You’ll still pay the fees, but you won’t have to come up with the cash upfront.
Your ability to get a zero-closing-cost loan depends on how much equity you have, Kapfidze said. “If you have a lot of equity, you can pretty easily roll it into the loan. But if you’re bumping up against whatever the loan-to-value (LTV) ratio limits are, then less so.”
Your best approach, he said, is to talk to lenders to find out if you’ll need to have cash on hand to close the mortgage. “I wouldn’t go in assuming you wouldn’t have to pay anything out of pocket,” Kapfidze said.
Does it make sense to refinance in this rising–interest rate environment?
Even when interest rates are on the rise, it’s not a bad time to consider a refinance. Making the choice to refinance should always be an individual one based on your own financial circumstances and current loan specifics. As a result, Kapfidze said, there’s definitely a lot of opportunity to actually end up with a lower interest rate in a rising rate environment.
“If you bought your house some years ago and you’ve improved your credit score meaningfully, it may be that even though rates are higher, your credit score is way better, so you can get a better rate,” he said.
And because home prices have been on the rise as well, homeowners who took out a loan that had a high LTV may get a better mortgage because their LTV is much lower as a result of that increased home value, Kapfidze said.
A final word
Refinancing a mortgage can make a lot of financial sense if the terms of that new loan result in savings over the long term. Therefore, before signing on the dotted line, it’s imperative you weigh all the pros — interest rate, loan term, monthly payment — against all the cons — closing costs, total interest paid during the loan term — when making the decision to refinance your mortgage.
Remaining focused on your own financial needs and goals and how a refinance can affect them should be the deciding factor in refinancing your mortgage.
This article contains links to LendingTree, our parent company.