Whenever interest rates drop or even fluctuate a bit, many people consider a refinance loan for their home. The object of the game? Reduce your mortgage payments. How do you decide if refinancing makes sense? The answer depends on many factors, including your tax bracket, the length of time you plan to stay in your home, and the additional costs you must pay for the refinancing.
When is a Refinance Loan Worth Doing?
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. So even if your rate change is less than one percentage point, you
may be able to save some money by refinancing.
Talk to some lenders to determine the available rates and the costs associated
with refinancing. These costs include appraisals, professional's fees, and
points
Determine what your new payment would be if you refinanced
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).
How Much Will it Cost to Refinance Your Mortgage?
When you refinance your mortgage, you usually pay off your
original mortgage and sign a new refinance loan. With a new refinance loan, you
again pay most of the same costs you paid to get your original mortgage:
settlement costs, discount points, and other fees. You also may be charged a
penalty for paying off your original loan early, although some states prohibit
this.
The total expense for refinancing a mortgage depends on the interest rate,
number of points, and other costs required to obtain a loan. To get 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.
How Many "Points" Should You Pay?
In 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. Points are charges banks impose on a loan to cover
the cost of doing business. They are often negotiable and may be waived in some
cases. Some lenders may offer zero points at a higher interest rate, which may
significantly reduce your initial costs, but your payments will be higher.
Shopping for points as well as interest rates will save you money. As a rule of
thumb, each point adds about an eighth to a quarter of one percent to the
interest rate. The lower the interest rate on the loan, the more points the
lending institution will charge. 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, and is not
recommended.
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