With interest rates at historic lows, many homeowners are considering refinancing. One question that seems to come up often is, should I pay closing costs or not? Here is a list of options to consider when looking at refinancing. Each option has it’s benefits, so there’s no one size fits all answer.
Interest Rate Points/Origination Fee
4.25% .875%
4.50% -.875% *
4.875% (-1.50%)*
* indicates a payment to your lender or broker – known as a “premium”
1. No Closing Cost Refinance - 4.875% with a 1.50% Premium Paid To Your Lender or Broker: Like the title says, it means you do not pay closing costs. The next question is who is paying them? Indirectly you are. By taking an interest rate higher than the market rate, the lender or broker can use the “Premium” in the interest rate to pay all your costs. For the purposes of this example, let’s take a look at how this no cost refinance works.
Your lender or broker will be paid 1.50% of $400,000 * 1.5% = $6,000. They will use this money and pay your closing costs of approximately $2,500. Leaving them $3,500 in gross revenue.
2. Low Closing Cost - 4.50% with a .875% Premium Paid To Your Lender or Broker: This is a combination of the No Closing Cost & Full Closing Cost Option. The lender or broker is paid their origination fees, and your are paying 3rd party costs, like title, escrow fee, credit reports, appraisal etc. In the above example your lender is being paid 400,000 * .875% = $3,500 gross revenue. You are responsible for the third party costs of $2,500.
3. Full Closing Costs – 4.25% with a .875% Loan Fee: In this example, you will pay the origination fee plus the 3rd party closing costs. That means you pay $3,500 loan fee + $2,500 in 3rd party fees or $6,000 total closing costs.
Now look at the monthly payments:
$400,000 Loan Amount * payments exclude taxes and insurance
4.25% = 1,967 Cost: $6,000
4.50% = 2,026 Cost: $2,500
4.875% = 2,116 Cost: $ 0.00
Compare: 4.25% v 4.875%
monthly savings: 2,116 – 1967 = 149 lower payment by selecting the 4.25% rate. Now look at the total costs divided by the savings: $6,000/149 = 40.26 months or 3.35 years to break even. That means after 3.35 years, the lower rate and paying the closing cost would have paid off.
Compare 4.875% v 4.50%
monthly savings: 2116 - 2026 = 90 lower payment by selecting the 4.50% rate. Now look at the total costs divided by the savings: $2,500/90 = 27.78 months or or 2.3 years to break even. That means after 2.3 years, the lower rate and paying the closing cost would have paid off.
Compare 4.50% v 4.25%
monthly savings: 2026 - 1967 = 59 lower payment by selecting the 4.25% rate. Now look at the total costs divided by the savings: $3,500/59 = 59.32 months or or 4.9 years to break even. That means after 4.90 years, the lower rate and paying the closing cost would have paid off.
A few other factors to consider is the loan to value ratio of the new loan to your home’s value. If for example, adding closing costs to your loan puts you into a higher loan to value bracket, you may opt to go with the lower closing cost or no cost option. Or if you have to pay private mortgage insurance by adding in closings cost, you may opt to go with the low or no closing cost option.
For additional refinancing question, feel free to contact me directly at (253) 472-1500. Ask for Kevin or visit us online at www.alltechmortgage.com
