Refinancing
Costs of Refinancing
Costs associated with refinancing can be divided into three different categories:
lender fees – which may include origination, application, points, appraisal, and credit report services;
third-party fees – these vary according to the state and the specific company with whom you choose to close your loan and may include fees for closing, title insurance, title exam, and recording; and pre-paid items - these are items taken at the time of closing but are not usually considered costs. These include items you paid for whether or not you refinance (for example taxes, interest, and hazard insurance).
When you refinance your mortgage, you usually pay off your original loan and sign a new one. With the new mortgage, you again pay most of the same costs you paid to get your original mortgage.  These can include 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 the new loan. To get the lowest rate offered, most mortgage companies will charge several points, and the total cost can run between three and six percent of the total amount you borrow.
All together, closing costs usually can range from 2% to 3% of your loan amount and you will be given an estimate of your closing costs shortly after your application has been received. Any prepayment penalty on a loan being refinanced will raise the amount needed to close. If there is enough equity in the home, your closing costs may be included in your new loan amount to keep your out-of-pocket costs as low as possible. If you change the product type or loan amount, the estimated closing costs will change. If this should occur, be sure to ask how the changes will affect your closing costs.
Refinance to Build Equity
Refinancing a mortgage essentially means paying off an existing loan and replacing it with a new one. Homeowners may decide to consider refinancing for a number of reasons. Potential reasons include: the chance to lock in to a lower interest rate; an opportunity to shorten the term of the mortgage; wanting to convert from an ARM to a fixed-rate mortgage (or vice versa); tapping into equity to finance another purchase; or to consolidate debt.
All of the above options have potential benefits as well as risks. But, if you’re looking into refinancing as a way of building equity or paying off your home more quickly, you’ll want to focus primarily on how refinancing can:
1) help secure a lower interest rate;
2) shorten your loan’s terms; and
3) convert between adjustable rate and fixed rate mortgages. It’s in these areas where refinancing can make a big difference in your effort to build equity in your home.
One of the best reasons to refinance is to lower the interest rate on loan you already have. The rule of thumb has usually been said to be that it was worth the money to refinance if you could reduce your interest rate by at least 2%. Today, however, many lenders say 1% savings is enough incentive to refinance. Decreasing your interest rate not only helps you save money, but increases the rate at which you build equity in your home, and can decrease the size of your monthly payment.
When interest rates fall, homeowners often have the opportunity to refinance an existing loan for another that, without much change in the monthly payment, has a shorter term. For that 30-year fixed-rate mortgage on a $100,000 home, refinancing from 9% to $5.5% cuts the term in half to 15 years, with only a slight change in the monthly payment from $804.62 to $817.08. If you’re looking to build equity, this would certainly be a good deal.
While adjustable rate mortgages start out offering lower rates than fixed-rate mortgages, periodic adjustments often result in rate increases that are higher than the rate available with a fixed-rate mortgage. When this occurs, converting to a fixed-rate mortgage results in a lower interest rate and gets rid of any fear of future interest rate hikes. On the other hand, converting from a fixed-rate loan to an adjustable rate mortgage can also be a sound financial strategy, especially if interest rates are falling. If rates continue to fall, the periodic rate adjustments on an adjustable rate mortgage result in decreasing rates and smaller monthly mortgage payments, eliminating the need to refinance every time rates drop.
Refinance to Get Cash
Another reason to consider refinancing a loan is the potential to simply get more cash. In such a situation, you basically refinance the loan for a higher amount of money. What this means is that you will owe more money than you initially began with and you may even lose a low interest that you had previously. However, you’ll still be reducing monthly payments and freeing up more money to spend on what new needs or situations may have arisen.
 One way to put more money in your pocket this way is to tap into the equity you've built in your home and do a "cash-out" refinancing. Basically, you can refinance for an amount higher than your current principal balance and then take the extra funds as cash. This can provide money for whatever purpose you may need - remodeling a home, paying off high-interest rate bills, or even sending children to college.
One of the most common reasons for refinancing is to consolidate debts like those accrued with credit cards. When you consolidate such debts through refinancing, you have one monthly payment instead of many and, in addition, this is generally lower than the combined amount of payments you were already making.
So, after exercising such a refinance option, even if you don’t end up walking away with extra cash, you’ll see a noticeable difference in the extra money remaining from paycheck each month.
For more information on refinancing to get cash and the difference between the option and a home equity loan, check out our Home Equity Cash Out page.
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