Mortgage refinancing calls for cost-benefit analysis

January 21, 2001

With mortgage rates falling, many homeowners want to know whether refinancing their loans makes sense.

Here are a few tips to help you decide.

Compare your existing interest rate to the new rate.

As a first step, compare the interest rate of your current mortgage to the interest rate of your new financing. Be sure to compare "apples to apples." For instance, if your existing loan is a 30-year, fixed-rate loan, compare the interest rate to the rate of a new 30-year, fixed-rate loan. The new interest rate should be at least one percentage point lower. Otherwise, the cost of refinancing probably will exceed any benefit you can get from a lower rate.

After finding the current principal balance of your mortgage (round to the nearest $1,000), require the new lender or mortgage broker to give you a written estimate of all closing costs. This document is called a "Good Faith Estimate." It should be provided before you pay for an appraisal.

The key is to make sure the estimate includes every fee the lender or mortgage broker will charge in connection with the loan. Typically, these fees will include appraisal and credit-report fees of as much as $350. Fees may also include "discount points" and "origination fees," based on a percentage of the new loan amount. A discount point is paid to lower the interest rate. The origination fee is charged for making the loan.

Some lenders and mortgage brokers also charge additional fees. These add-on fees are given various names, such as processing fees, underwriting fees, commitment fees, document preparation fees and tax services fees.

To make a fair comparison with your existing loan, you should insist initially on a Good Faith Estimate for a loan that equals the principal balance of your existing loan. You should do this even if you intend to borrow more to cover closing costs. The object is to isolate, as accurately as possible, all the costs of refinancing.

To ensure the Good Faith Estimate is as complete as possible, you could ask the person providing it to give you a statement in writing that the lender or broker will charge no other fees or points except as shown on the estimate.

Next, compare the total monthly payment of principal, taxes and insurance (homeowners insurance and mortgage insurance, if any) of your existing loan to the total monthly payment of the new loan. The difference is your "monthly savings."

Now, divide the total refinancing cost shown on your estimate by the monthly saving. The result gives you the number of months it will take to recapture refinancing costs. This is called the "payback period." For instance, if the total cost of refinancing is $2,400 and the monthly savings is $100, the payback period is 24 months; it will take 24 months to recapture the cost of refinancing even if you roll in the $3,000 to the amount of your new loan. You don't start to realize any net savings from a new loan until after the payback period.

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