While deciding whether to refinance your mortgage may seem mysterious, when you boil it down, it's just simple math.
Here’s a recent reader question – maybe you’ve wondered about it as well:
My bank called and offered me to refinance at no charge: no appraisal fee, no refinance fee for a rate of 4.5 percent. My current rate is 5.375 percent, and I have had this mortgage since 2008. My principal is $144,423, and I’m paying about $192 in principal each month and $647 in interest.
Anyway, would that make sense for me to do this refi? The only catch is that my 30-year fixed loan would start over now – so I’ve been paying already for 2 1/2 years, which would mean I start from scratch again.
What’s more beneficial for me? The difference in price each month is about $100 less if I get the refi at 4.5 percent. They are also offering me to get a 20-year fixed loan at 4.5 percent, which would increase my monthly payments but decrease the payment overall. What should I do? – Corinne
Corinne, here’s how you – and anyone else in your situation – can figure out the refinance question. Basically, it’s a matter of cost vs. benefit. In other words, divide the cost of the refinance by the monthly benefit you’ll receive, then see how many months it will take to make the transaction profitable.
If the fees you pay to refinance are $2,000, and you save $100/month as a result, it will take 20 months to recoup your cost. If you’re going to stay in the house exactly 20 months, you break even. If you move sooner than that, you lose money. For every month you stay longer, you come out $100 ahead.
Now at this point, you may be thinking I didn’t read Corrine’s question very well. After all, she plainly says “My bank called and offered me to refinance at no charge: no appraisal fee, no refinance fee.” But there’s almost no such thing as a fee-free refinance. I can use myself as an example – I refinanced my mortgage a couple of years ago. Here are the expenses I paid:
Recording Fees $175.00
City/County Tax Stamps $ 600.00
State Tax Stamps: $1,050.00
Credit report: $25.00
Underwriting Fees: $595.00
Escrow Fee: $150.00
Title Search $165.00
Title Insurance: $1,125.00
Title Endorsements: $140.00
Express Mail: $75.00
Total Expenses: $4,100.00
I did lots of negotiating to keep my expenses low (see Mortgage Shopping 101 – Negotiating) and for the most part I was pretty successful.: The fee associated with the actual mortgage loan – the underwriting fee – was $595.00. But as you can see from the above list, that’s not all there is. In my state (Florida) there’s no negotiating title fees and tax stamps and there’s no getting around them: they’re set by law.
The point is that Corine needs to be aware of the entire cost of refinancing her mortgage and not rely on the bank’s claim that they’re refinancing her at no charge.
In addition, there could be a very high charge in this refinance that’s virtually invisible – the interest rate that Corinne is agreeing to pay for the next 30 years. If rates are currently 4.25 percent and Corinne’s rate is 4.5 percent, that’s money that the lender is making and Corinne is losing. And that’s why you’ll often see lenders that offer “no-fee” mortgages: sure, there’s no underwriting fee, like the one I paid. But these loans are often at higher-than-market rates, which results in the lender making a lot more than if they’d charged $595.
Bottom line? If you’re considering a refinance, go into it with your eyes fully open. Find out how much it will actually cost to refinance a mortgage where you live, including government and closing costs. Then, check out a mortgage search tool like the one we have here to find the absolute best rate. Then make your decision.
As far as a shorter mortgage – 20 years instead of 30 – the shorter mortgage, the less interest you pay over the life of the loan. (Same goes for any loan, like a car loan.)
The shortest loan you can afford to make payments on is the best. Of course, your payments will be higher. And if you get the longer loan, nothing stops you from paying extra every month should you have the cash on hand.