Are you considering a mortgage refinance but unsure of the costs? Refinancing your mortgage can save you thousands of dollars in the long term. When refinancing, negotiating lower interest rates, tapping into property equity, or shortening the loan term may be possible. However, the cost of refinancing your mortgage could outweigh any benefits of getting a new mortgage.
Refinancing a mortgage—replacing your current loan with a new one—involves closing costs. The fees included in refinance are typically between 2% and 6% of the loan amount. While a refinance can offer numerous benefits, it’s crucial to consider the costs against the potential savings. Refinancing can be a savvy financial move if you can secure a new mortgage with better terms.
This article explores the various costs associated with refinancing a mortgage. You will also learn how to lower refinancing costs for a better mortgage deal. Knowing what you can expect to pay to refinance can help determine whether it’s viable for your financial situation.
What Is the Purpose of Refinancing a Mortgage?
A common reason for mortgage refinancing is to save money. Replacing an existing mortgage with one that has lower mortgage rates or a shorter term can reduce monthly payments, thus building equity in a home faster. Other reasons include debt consolidation, releasing cash from equity, or negotiating a longer term.
Another reason to consider a refinance is private mortgage insurance. For example, many homeowners switch from an FHA loan to a conventional loan when they reach 20% equity. This refinancing move allows them to eliminate the insurance requirements and associated costs.
Homeowners who struggle to make mortgage payments may consider a refinance. Securing a mortgage with a longer term can reduce the monthly payment. However, paying interest on the loan over a longer term makes it more expensive.
Whether refinancing your mortgage is a good financial decision depends on whether the savings justify refinance closing costs.
What Should I Expect to Pay in Closing Costs for a Refinance?
Typical closing costs to refinance your mortgage are between 2% and 6% of the refinanced loan. The up-front costs you can expect to pay depend on the loan amount, where you live, and interest rates. Also, factors like debt-to-income (DTI) ratio, loan-to-value (LTV) ratio, and your credit score impact closing costs.
According to Freddie Mac, average closing fees are around $5,000. However, the loan principal, mortgage type, and where you are located all affect the mortgage refinance costs.
Other factors affecting average closing costs include:
- The amount of available home equity
- Mortgage refinance program
- Whether it’s a fixed-rate mortgage or an adjustable-rate mortgage
- Loan term
Like taking out a conventional loan, your lender will consider your financial position, ability to make the monthly mortgage payment, and credit history. It’s also vital to check the small print of your existing mortgage loan terms. Some mortgages have prepayment penalties, which can increase the cost of refinancing a mortgage.
Mortgage refinancing fees
Mortgage refinance closing costs add up quickly; therefore, it’s vital to understand the fees associated with refinancing. Here is what you can expect to pay in 2023:
- Application fee: $500
- Appraisal fee: $300 to $500
- Loan origination fee: 0.5% to 1% of the total loan amount
- Recording fee: The amount depends on state and county
- Title search fee: $200 to $400
- Title insurance fee: Up to $1,000
- Attorney fees: Vary depending on your state
- Survey fees: $300 to $900
- Credit check fee: $25 to $75
- Discount points: Up to 1% of the loan amount
Depending on the mortgage type and home equity, you may have varying costs associated with mortgage insurance premiums.
Here is a list of what you could expect to pay for private mortgage insurance in refinance closing costs:
- Conventional loans: 0.15% to 1.95% of the loan amount annually
- VA loans: 0.5% to 3.3% for the funding fee
- FHA loans: 1.75% up-front fee; 0.15% to 0.75% of the loan amount annually
- USDA loans: 1% up-front loan guarantee fee; 0.35% annual guarantee fee
Each mortgage lender has varying fees, and you may not need private mortgage insurance. Also, depending on the mortgage type, some lenders will waive certain fees. Therefore, it’s vital to consider all closing costs when taking out a new loan to ensure refinancing makes sense for your financial situation.
The Cost of Refinancing a Mortgage: Examples
The best way to understand how refinance closing costs affect your monthly payment is to see examples.
Financial calculators can often help you determine if you can save money on your monthly payments and the total cost of the new mortgage. The formula is generally this:
[Closing costs + fees] ÷ monthly savings = the number of months it takes to break even
Before refinancing, consider how long you plan to remain in your home. If you plan to move in the next few years, refinance closing costs may not allow you to break even. Therefore, it would make more sense to continue with your current mortgage.
Here are a few scenarios to illustrate how calculating fees and costs can help determine if a refinance makes financial sense.
Example No. 1
Let’s say a homeowner has a mortgage balance of $185,000 and wants to reduce the monthly payment. They find a new mortgage with better terms that allows them to save $175 per month. The closing costs add up to 3% of the new mortgage balance, $5,500. Therefore, their break-even point is 31 months, meaning they will save money on their mortgage after two and a half years.
The homeowner could choose a fixed-rate loan or a new loan with an adjustable interest rate, depending on market conditions.
Example No. 2
An investor has an investment property and wants to turn home equity into cash. They have a loan balance of $300,000 on a $750,000 mortgage. The borrower can use a cash-out refinance by taking out a new mortgage. For example, they want to raise $200,000 to invest in a new property. In that case, a mortgage broker can find a competitive mortgage with a new loan balance of $500,000, and the investor gets $200,000 in cash.
It’s important to note that cash-out refinances have higher interest costs than rate-reduction refinances. Therefore, it’s vital to calculate potential savings over the loan term.
Example No. 3
A homeowner has a mortgage loan issued by the Federal Housing Administration (FHA). Because of this, they must make monthly mortgage insurance payments. However, when they have at least 20% home equity, they can refinance into a new loan, eliminating the MIP (mortgage insurance premium). This move could save the homeowner around 0.45% to 1.05% of the original loan amount.
Even though the new loan interest rate could be higher, securing a shorter-term loan and avoiding the insurance premium could result in significant long-term savings.
Do You Have to Pay Closing Costs Every Time You Refinance?
You must pay fees when refinancing a mortgage. Average refinance closing costs are typically the same as when taking your original mortgage. You can expect to pay closing costs of between 2% and 6% of the loan principal. In some cases, you can negotiate some closing costs with the lender.
Therefore, when considering a refinance, consider all costs like origination fees, title, appraisal fees, monthly payment savings, and how long you plan to stay in the home.
Is There a Way to Avoid Closing Costs When Refinancing?
You can avoid paying closing costs in a lump sum when refinancing a mortgage. This is called a no-closing-cost refinance. This option allows you to roll closing costs into the loan’s term and pay them as part of your monthly payment. However, you cannot completely avoid all refinance closing costs.
Also called a “no-closing-cost refi,” delaying paying closing costs during a refinance makes financial sense when you plan to hold the property for less than five years. This way, you avoid paying thousands of dollars in closing costs and interest over the loan term.
If you plan to hold the property for over five years, a no-closing-cost refi has a higher interest rate. Therefore, you pay interest on the costs, resulting in a higher monthly payment and a more expensive mortgage. In that case, it’s best to pay the costs up front.
How to Lower the Cost of Refinancing a Mortgage
There are several options to reduce costs when closing a refinance mortgage. Of course, there’s no down payment required to refinance. However, you must have the money upfront when refinancing your mortgage. Therefore, exploring options to reduce costs is a smart personal finance decision.
Here are a few options that may help lower monthly payments and get a better mortgage deal.
Improve your credit score
Boosting your credit score is wise before considering a mortgage refinance. A score of at least 740 will help you lock in the lowest interest rate and improve your chances of loan approval. It may also give you more leverage to negotiate certain closing costs with your lender.
Some ways of improving your credit score are to pay off credit card debt, pay bills on time, and limit new credit applications before applying for a mortgage.
Shop around for better mortgage offers and rates
Compare offers from multiple lenders to ensure you get the best refinance rates. In many cases, a mortgage broker has access to several refinance lenders and banks. They can also give you the best financial advice for your circumstances. It is also good to compare the benefits of an adjustable-rate mortgage over a fixed-rate mortgage.
Also, don’t forget to get a quote from your existing lender. They may be willing to waive or reduce some costs, like the application fee or appraisal fee.
Use a mortgage refinance calculator
A mortgage refinance calculator can help you determine your closing costs and how much your monthly payments will be. This way, you can estimate the potential savings of taking out a new mortgage.
Negotiate mortgage refinance costs and fees
One of the best ways to reduce the cost of refinancing a home loan is to negotiate closing costs with the refinance lender. Here is a list of the common closing costs your refinancing lender may be willing to reduce or waive:
- Home appraisal fees, if you recently had a property survey done
- Title insurance
- Credit report fees
- Title search fees
Certain expenses cannot be negotiated. For example, your loan officer cannot reduce fees charged by third parties. These may include the property survey, recording fees, and home appraisal to determine current market value.
Consider if buying mortgage points can reduce the cost
You may be able to pay less on a new mortgage if you buy mortgage points. Some lenders allow you to pay discount points upfront to offer a better interest rate. Typically, 1% of the loan amount is one point. However, this option only saves money if you plan to stay in your home for a long time.
Consider a no-closing-cost refinance option
If you are struggling to pay the costs of refinancing a mortgage, rolling the fees into a new loan can be a good option. However, your lender may increase the interest rate, making the mortgage more expensive in the long term. Therefore, it’s usually best to pay the closing costs upfront.
How to Refinance a Mortgage With Bad Credit
Like any loan application, lenders require borrowers to have a good credit score to approve refinancing a mortgage. Therefore, it can be tricky to get a new mortgage if your credit history is less than ideal.
However, certain strategies can help you secure a new deal. Here are a few:
- Improve your credit score: Getting your finances in order can improve your credit score. Bringing your score above 620 will help you refinance your mortgage.
- Shop around lenders: Some lenders may give loans to homeowners with a score of below 620. However, you typically must show other ways that you are creditworthy.
- FHA loan: You can refinance an FHA loan into an FHA Streamline Refinance without the usual credit check.
- Apply with a non-occupying cosigner: If you struggle to refinance your mortgage due to bad credit, applying with a co-client could be a good solution. The lender also considers their monthly income, assets, and credit score during the application process.
The Cost to Refinance a Mortgage—Conclusion
Refinancing a mortgage can save you thousands of dollars over time. A refinance can be a useful financial strategy to get lower interest rates, pay off a mortgage faster, or consolidate debt. In addition, you can use a cash-out refinance to access equity. Refinancing is also helpful if you have trouble making payments or want to eliminate premiums on mortgage insurance.
How much does it cost to refinance a mortgage? That depends on your lender’s closing costs, fees, and interest rates. Generally, you must pay between 2% and 6% of the loan principal in closing expenses. Therefore, strategies to lower closing costs can be a wise investment move to help secure your financial position.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.