Factors to Consider When Refinancing Your Mortgage

Refinancing is the process of replacing your current mortgage with a new one based on today's terms and interest rates. Is refinancing worth it? That's the key consideration. Fees and expenses vary by lender, interest rate and the type of loan. Your goal is to sort through the options and figure out if the cost of refinancing ultimately will save you money for the rest of the time you are likely to own the house.

Three key factors affect the time-to-payback for refinancing:

Factor No. 1:

How Much You Borrow

If your house appreciated in value, you might be able to get a bigger mortgage and use the extra cash for remodeling or other expenses. Lenders calculate many refinancing costs as a percentage of the loan amount. As a result, larger loans might cost more to refinance than smaller loans. But very small loans, of about $100,000 or less, also tend to carry higher interest rates and higher fees than larger loans because small loans are less profitable for lenders.

Factor No. 2:

Loan Types and Fees

Some loans cost more than others - FHA loans, for instance, require an upfront mortgage insurance fee of 1.75 percent of the loan paid to the government. Title and escrow charges vary with state and loan type.

Factor No. 3:

Your Income, Credit Score & Debt Amounts

If your income, debt levels, credit score or other factors have changed since you got your current mortgage, lenders are likely to offer you different terms.

Just like getting a mortgage when you buy a house, refinancing involves many professionals from different companies, all working together, and all charging fees. Here's a breakdown of the key terms and fees and what you can do to minimize the total cost of refinancing. Generally, the lower the interest rate, the higher are the closing fees.

Pay attention to the estimated closing costs in a refinance, because these — in addition to the interest rate — will help determine whether refinancing is worth it.

Are these fees negotiable?

In some loan programs, the government sets the origination fee and is not negotiable under any circumstance. Origination fees in non-government loans may be negotiable, as well as discount points. The Loan Estimate form contains a section entitled "Origination Charges." That number is the total for the fees the lender charges for originating your loan. It doesn't really matter what lenders call the individual charges that make up this total - origination fee, processing, underwriting, loan documentation, administration, whatever. What matters is the total, and that's likely negotiable.

Source: Federal Reserve

Are these fees negotiable?

Most third-party fees are negotiable, either in their amounts or who pays the fee. You may not be able to choose who your lender uses to provide third-party services. But your lender may waive a fee it controls, or agree to pay a third party's fee. Appraisal services and credit report fee amounts are not negotiable. You may be able to choose your title and escrow services, and in that case, the fees are negotiable. The same applies to inspections and surveys. Also review and shop for homeowners' insurance coverage when you refinance.

Source: Federal Reserve

Are these fees or prepaids negotiable?

These items are almost never negotiable.

Source: Federal Reserve

Loan Points Explained: Par, Rebate & Discount Points

Every home loan comes with one of three types of price points: par, rebate and discount.

Par Pricing

Par pricing is neutral and will cost you zero points. (A point is one percent of the loan amount) It's the rate you qualify for based on your credit rating, loan-to-value and other factors.

Rebate Pricing

Rebate pricing means you choose a higher interest rate, but in exchange, you receive a rebate. You can use the rebate to cover some or all of your closing costs. Rebate pricing is what lenders mean when they advertise a no closing cost refinance.

Discount Points

Discount pricing gets you a lower-than-market interest rate, but it costs extra. The extra costs are called discount points. Paying higher fees to get a lower refinance rate is also called buying down the loan.

Source: Bankrate.com's annual closing costs survey. According to Bankrate, the survey includes lender fees and third-party fees. It excludes title insurance, title search, taxes, property insurance, association fees, interest and other prepaid items.

Refinancing is only worth it when you can save more than what you have to spend to refinance. You will break even on the refinancing when the cost to refinance equals the savings you expect to gain. Here's how to estimate the point at which you break even and beyond.

Using the quick, dirty, and dangerous way, your refinance might look like this: If it costs $3,500 to refinance, and your new payment is $70 per month less than the old payment, the estimated break-even is 50 months ($3,500 / $70), or four years and two months.

Keep in mind that while the quick, dirty, and dangerous way is easy, it could also lead you to the wrong conclusion. That's because the difference between your old payment and your new payment does NOT equal true savings — some of the difference is the result of stretching out the remaining balance of your loan over a new loan term.

In other words, you pay less each month, but you pay for more months.

Another disadvantage of the quick, dirty, and dangerous method is it can't calculate the savings you get by refinancing to a 15-year mortgage, because even if the refinance loan costs $100,000 less over its life than the old loan, its payment is almost certainly greater.

Just as every household budget is different, each refinance situation is different. Whether you should refinance depends on your circumstances and the deal lenders offer. Which of the following three situations is most like yours?

Ditching Mortgage Insurance

RELEVANT FACTS

Existing balance: $180,771
Property value: $232,000
LTV: 77.9%
Refinance breakeven: 21 months

Emma's Story
Emma bought her house three years ago for $200,000, putting $10,000 down and financing $190,000. Her interest rate is 4.75 percent.

Refinance Opportunity
Emma was offered a refinance loan at 3.75 percent with refinancing fees costing $3,615. Her property value today is $232,000, and her loan balance is $180,771. She's not sure how long she'll keep her home, but thinks it will be at least three years. Refinancing would reduce her payment by $154, but it will take 33 months — nearly three years — to recoup her costs with a lower mortgage payment.

Should Emma Refinance?
Emma's home's value has appreciated to the point that her loan-to-value would be less than 80 percent, which would allow her to drop her mortgage insurance costs. When her PMI premiums (.58 percent per year) are subtracted, Emma's monthly payment drops by $218 and her breakeven is slashed to just 21 months.

Choosing a Higher Rate to Save Money

RELEVANT FACTS

Matt is uncertain how long he will own property

Existing rate: 5.5%
Offer 1 Rate: 3.5%
Offer 1 closing costs: $15,000
Offer 1 break-even: 43 months
Offer 2 Rate: 4.15%
Offer 2 closing costs: $0
Offer 2 break-even: 1 month

Matt's Story
Matt is a divorced 30-something who owns a home that he originally purchased with his ex-wife. He never got around to refinancing and is paying 5.5 percent on an eight-year-old mortgage. The remaining balance of his $350,000 loan is $303,933.

Refinance Opportunity
Matt is considering refinancing to a loan with a 3.5 percent rate. His payment will go down by $622 a month! However, the closing costs for the new loan are over $15,000, and his breakeven point is 43 months. Matt's not really sure how long he'll keep his house, and that's a lot of money to pay upfront — if he leaves in just two years, he'll lose thousands.

Should Matt Refinance?
Matt should consider a loan with fewer upfront costs, even if the interest rate is higher. For example, if he chooses a no closing cost refinance with a 4.15 percent interest rate, he breaks even in just one month, lowers his payment by $510 and would save nearly $11,000 over the next three years.

Shortening Loan Term

RELEVANT FACTS

Existing rate & term: 6% @18 yrs remaining
Offer 1 rate & term: 4% @30 years
Offer 1 lifetime interest: $33,548 more than existing loan
Offer 2 rate & term: 3.25% @ 15 years
Offer 2 lifetime interest: $47,377 less than existing loan

Walter's Story
Walter has known for a few years that his mortgage rate is too high, but he never got around to refinancing. His mortgage is 12 years old and he's paying 6 percent. Of the original $400,000 balance, he owes $316,318.

Refinance Opportunity
If Walter refinances to a new 30-year loan at 4 percent (costing $7,908 in fees), his payment will drop by $888 from $2,398 to $1,510!

Should Walter Refinance?
It would take a total of 42 years to get rid of his mortgage if he does this, and it will cost him an extra $33,548. Walter should think about a 15-year refinance. The rate is 3.25 percent, his payment is still $175 less, and he'll save $47,377.

Why would you shop around for a refinance mortgage? Why wouldn't you? A 2011 Stanford University study concluded that many consumers do not shop when financing a home because they don't realize how much they'd save if they did — a median $2,664 at closing for a $200,000 mortgage! And there's more — a Mortgage Industry Advisory Corporation (MIAC) study found that on any given day, average mortgage rates vary between lenders by .25 percent (for conforming and government loans) to over 0.50 percent (for jumbo loans). The chart below shows how this translates into real-word purchasing power — over time, choosing the right mortgage could get you anything from a free vacation to a new car.

5 Steps to Compare Mortgage Quotes

Follow these fine steps when you comparison shop for a loan. But let's start with the premise — does comparison shopping matter? Yes. According to Stanford University researchers, you need at least four mortgage quotes to have a chance at getting the best deal. According to the Federal Reserve of Chicago, home loan comparison shoppers save thousands in lifetime costs in comparison to non-shoppers. Here's how to shop systematically for the best deal on a refinance.

1. Compare Fairly
Try to get your quotes quickly — this is important because mortgage rates can and do change several times a day. A Monday quote from Lender A can't be compared reliably to a Tuesday quote from Lender B. If the lender issues a Good Faith Estimate, it should indicate how long the quote is valid.

2. Narrow the Field
Review your mortgage quotes and pick two lenders with the most competitive pricing. Contact them both and discuss your home refinance. Go with the loan professional who is most responsive and who provides the best answers to your questions. Make sure you're comfortable with this person — you may discuss sensitive topics (i.e., money), and you're trusting him or her with an expensive transaction.

3. Ask For a GFE or CFPB Loan Estimate
A mortgage quote should contain the interest rate and the costs of getting the loan, including fees, service charges or points paid to the lender, and money paid to third parties like appraisers and title insurers. Ask for a Good Faith Estimate (GFE) or CFPB Loan Estimate instead of a worksheet or scenario. The GFE and Loan Estimate carry legal obligations to honor the quote, while a worksheet does not.

4. Be Prepared to Share Your Financial Information
Lender needs personal information about you to provide a GFE or Loan Estimate, because your rate depends on your credit score, home value and loan amount, loan type and property use. Without this information, lenders can give you a quote, but it might not be based in reality.

5. Review the Short- and Long-Term Costs
When comparing mortgage quotes, calculate the difference in monthly payments, closing costs and lifetime interest expenses. Normally, the loans with the lowest interest rates have the highest costs. Perform a breakeven analysis on these elements to choose a loan. Take the difference in closing costs and divide that by the difference in payments. The number of months is the length of time it will take for the more expensive loan to pay off.

Let's look at a simple example of how to calculate the breakeven point on two loans with different interest rates and closing costs.

In the example above, Loan A has a lower interest rate and monthly payment than Loan B, but higher closing costs. If you choose Loan A over Loan B, it will take almost nine years to make up the difference in the closing costs. If you plan to keep the loan for more than nine years, then Loan A is the better deal. However, if you think you may sell the home or refinance in less than nine years, then Loan B is the smarter choice.

No-Cost Refinances

Refinancing a mortgage is expensive, and it may take some time for the consequent savings to offset the upfront costs. That's the idea behind the so-called no-cost refinance — there's no free lunch.

According to the Federal Reserve, no-cost means different things to different lenders, so check your GFE or Loan Estimate to see exactly which costs are covered. For example:

• The mortgage lender eliminates its total origination charges, but not third-party fees (like title insurance) or prepaid expenses (like property taxes).
• The lender covers all of its fees plus third-party charges, but not prepaid items.
• The mortgage lender absorbs all fees, including loan costs and prepaid expenses.

When the lender absorbs refinancing costs, you pay a higher interest rate. There's another way to capture the benefits of a no-cost refinance that does not increase your rate.

The No-Cash Alternative

Avoid paying the fees out of pocket by having the lender add closing costs to o your loan balance. Because you borrow more money, you need sufficient home equity to qualify for this kind of refinance. Although you'll get a lower interest rate, it will be applied against a larger loan balance.

In most cases, paying for a lower rate saves money only if you keep the loan for several years. The following example has been taken from actual loan pricing from a national mortgage lender and illustrates both types of "no closing cost" refinance. The loan with the higher rate has no lender fees, and the loan with the lower rate has lender fees, which have been added to the loan amount

How you pay for refinancing costs depends on your finances, the structure of the "no-cost" offers you get from lenders, and how long you intend to keep the property. One thing always holds true — lower refinance rates cost more. Higher rates cost less. And there are no freebies, only trade-offs.

When you apply for a mortgage you will receive a form known as the GFE or Loan Estimate. These forms get their power because by law, lenders must disclose fact of their offers reasonably accurately. They must reissue a new GFE or Loan Estimate within three business days if there is a material change to your file. When you lock your rate, for example, or if you choose a different loan. At closing, either the GFE is reconciled to the Settlement Statement (HUD-1 form), or the Loan Estimate is reconciled to the Closing Disclosure. The lender must refund cost increases to the borrower. The final GFE or Loan Estimate must be provided to the borrower no later than three business days prior to closing.

The law classifies charges into three categories: those that can't vary from disclosures at all, those that can vary within predetermined ranges, and those with no limits on variability.

Charges That Cannot Increase

• Origination fees
• Discount or premium points for a specific interest rate selected
• Adjusted origination charges (after the interest rate is locked)
• Transfer taxes

Charges that Cannot Increase >10%

• Required settlement services that the lender selects, such as the appraisal
• Title services, lender's title insurance or other required services *
• Government recording charges

Charges That Can Increase Without Limit

• Title services, lender's title insurance and required settlement services the borrower can choose **
• Owner's title insurance and other non-required services **
• Initial deposit for borrower escrow account
• Daily interest charges
• Homeowner's insurance

*If chosen by lender or if the borrower uses a company identified on the lender's Settlement Services Provider List.

**If the borrower picks a service provider not included on the Settlement Services Provider list.

For the "Charges that Cannot Increase More Than 10%" column, the total of the listed charges can't increase by more than 10 percent over the amount disclosed in the GFE.