Understand the Real Cost of Refinancing A Mortgage
With interest rates low and seeming not yet prepared to head north, refinancing a mortgage remains irresistible to many homeowners. But in gauging whether a refinancing makes financial sense, don’t overlook the less obvious expense that goes with it: the various fees that can run into the thousands of dollars. (See also: Should You Refinance Your Mortgage When Interest Rates Drop?)
In general, the panoply of fees associated with a mortgage is the same whether the loan is for a new purchase or to refinance an existing mortgage, although a lender will sometimes forgo some fees to refinance a loan it has already underwritten – more about that in a moment. Mortgage fees generally fall into three categories:
Over the years, lenders have found new ways to profit from loan-making – underwriting fees, “processing” fees, charges for routine administrative work like copying and delivering documents – much to the surprise and distress of unwary borrowers. In 2008, the Federal Reserve reported that it wasn’t unusual to pay as much as 6% of the loan amount in fees, mostly to the lender. But now there’s a limit to how much a lender can extract from a borrower in this fashion — a limit imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under regulations set by the Consumer Financial Protection Bureau (CFPB), a lender cannot charge the borrower more than 3% in fees on most loans if it wants legal liability protection from distressed borrowers. (In addition to various fees, the cap also limits points paid for a lower interest rate and commissions paid to lead-finders like brokers. For loans under $100,000, the cap reaches as high as 8%. A loan that meets these and other conditions is deemed a “qualified mortgage.”)
Some of the costs of arranging a mortgage accrue not to the lender but to other companies that provide services that facilitate the transaction – fundamentally for the lender’s due diligence. Commonly, these include the property survey and appraisal, the title search (to make sure there are no liens on the property) and title insurance for the bank, in case the title search is badly executed. (Some lenders urge borrowers to take out title insurance policies for themselves, but Barry Zigas, director of housing policy for the Consumer Federation of America, says it’s unnecessary. “The likelihood of finding a problem in the title of a property that’s been bought and sold on the open market is very small,” particularly since the lender’s title search will almost always uncover it. The exceptions, he says, are “so rare, that it’s an expense that does not pay off for the borrower.”) Such ancillary fees can include in some jurisdictions the cost of hiring your lawyer, and your bank’s lawyer.
In general these fees are not included in the 3% cap set by the CFPB, except when the third parties are in fact affiliates of the lender, or when the lender retains a share of those fees rather than passing them on.
There are two basic kinds of government fees. First, in at least nine states and the District of Columbia, state and local governments assess a tax for, as New York state puts it, “the privilege of recording a mortgage.” And the various government agencies that support housing with special loan programs charge their own fees. For example, the U.S. Department of Agriculture, which guarantees home loans in struggling rural areas, requires mortgage insurance that costs 2% of the face value of the loan at the outset and .4% of the remaining principal annually. Military veterans who refinance a conventional mortgage using a loan guaranty from the Department of Veterans Affairs pay a funding fee that ranges from 2.15% to 3.3% of the loan, though refinancing an existing V.A. loan costs just .5%.
The ReFi Discount
Often times, lenders will give a refinancing homeowner a break on the fees, says Zigas. “They already know your payment history and that you're creditworthy – especially if they're lowering your rate, that's an easy decision for your lender to make.” Third-party services like appraisals and title searches and insurance can be streamlined, or discounted, as well, but, says Zigas, “the consumer has to insist that the lender seek that out or seek it out themselves, because otherwise the easiest thing for a lender to do is slot in a title search and go to a vendor who charges the consumer for a whole new title search, which really isn’t necessary.” (Borrowers participating in the government’s Home Affordable Refinance Program, who must have purchased their homes on or before May 31, 2009, can also pay streamlined fees.) And a steely negotiator might be able to negotiate away some of the lender’s various fees – if the borrower is willing to walk away from the loan.
Once you’ve established the costs of the new loan, it’s important to compare it to your current monthly payment, says Shashin Shah, a certified financial planner in Dallas. For a borrower with, say, 25 years left on his mortgage, the payment on a 30-year note will be lower, in part, because of the longer loan term. “In order to compare the apples-to-apples benefit, they should see what the extra amount is they will need to pay every month to have the mortgage paid off in 25 years,” Shah says. “That will usually give a homeowner a better estimate of whether the cost plus the new rate is saving money.”
The Bottom Line
Fees for refinancing a mortgage are generally the same as for a purchase loan, but refinancing borrowers often pay a discount for a streamlined transaction. Even so, it’s important to harmonize the prospective new loan with your existing loan to see if you’re really saving money.