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Homeowners refinance for various reasons, but that process comes at a cost. You must weigh your refinancing closing costs as part of the process to ensure a refinance works in your favor.
In plain terms, a refinance is simply a new mortgage, so if you’ve gone through the process of securing a loan on your property recently, you should be familiar with the steps you must go through and the documentation you’ll need to provide.
Here are some good things to know if you’re weighing the benefits of a refinance in the future.
Reasons to Refinance
Refinancing revolves around creating more favorable overall terms for your personal finances. You can break down that reason into more specific types of motivation.
Lowering your monthly payment
A refinance can immediately contribute to your bottom line if you have a fixed-rate mortgage with a higher APR than current market conditions. Refinancing can be particularly beneficial in a declining interest rate environment or if the homeowner’s credit situation has improved since securing the original mortgage and is now considered less of a credit risk.
Shortening your loan term
If you want to pay off your mortgage in a shorter timeframe due to a bump in your income, you can refinance your 30-year mortgage to a 15-year loan and pay less interest overall.
Lengthening your loan term
You can also extend the loan term to create lower monthly payments. However, you will pay more interest over the life of the loan.
Get rid of private mortgage insurance (PMI)
If your home’s value has increased and you now have 20% or more in equity, refinancing is one way to eliminate PMI.
Change from an adjustable rate to a fixed-rate loan
ARM loans build in rates that increase after a locked in period, which can greatly impact your finances. Refinancing to a fixed-rate loan removes uncertainties so you can more accurately budget from month to month.
Pulling out cash for other uses
You can use home equity that you pull out with a refinance to pay down debts, make home improvements, or pay for major expenses, such as your children’s college costs.
Whatever your reasons for refinancing, making this move can save you lots of money, give you financial flexibility, and more closely align with your current financial situation and goals.
How Much are Closing Costs on a Mortgage Refinance?
Mortgage refinancing closing costs vary according to the size of your loan and where you live. A good rule of them is that you can expect to pay 2-5% of the loan principal amount in closing costs. For example, if you refinance a $300,000 mortgage, expect to pay anywhere from $6,000 to $15,000 in closing costs. To minimize the impact, homeowners often roll these costs in with the loan.
These are the fees and costs you’ll encounter when you refinance:
- Application fee
- Origination or underwriting fee
- Recording fee
- Appraisal fee
- Credit check fee
- Title services
- Survey fee
- Attorney costs or closing fees
Depending on your situation, you may get a break if you refinance with your current lender. You may also find favorable terms with lenders who are anxious to do business with you. In most cases, you can negotiate the closing costs, points, and lender origination fees.
If your credit and finances are excellent, you may also get preferred status, which could reduce your closing costs. It never hurts to ask, which is precisely what you should do as you shop around for the most favorable terms.
» MORE: See today’s refinance rates
Documentation You’ll Need to Provide
You can streamline your refinancing process if you gather these documents before you start working with a lender. All lenders have slightly different requirements, but these are common requests in most cases.
- Proof of income. Your last 30 days of pay stubs, current tax returns, tax forms such as W-2 and 1099 forms, and other related income documents.
- Insurance. A copy of your homeowners’ insurance and title policies to confirm taxes, names on the title, and legal descriptions of the property.
- Credit information. Lenders will pull credit reports, but you may be asked to substantiate anything that is flagged and raises questions.
- Monthly debts. Your lender will be able to see your debts during a credit check, but you will still need to verify them by supplying current mortgage statements, home equity, auto and student loans, and other encumbrances.
- Total assets. You must document your other financial assets, including savings accounts, stocks and bonds, mutual funds, retirement accounts, and other real estate holdings.
- Appraisal. Your lender will probably also ask for a current appraisal of the house.
- Loan to Value appraisal. Lenders usually also ask for an appraisal of how much your house is worth compared to what you owe on the existing loan.
Risks of Refinancing
Refinancing a home mortgage is beneficial for many homeowners, but there are some risks to note. It’s essential to understand these potential pitfalls before deciding to refinance.
Closing costs can be substantial, and you’ll need to consider how they impact your overall refinance break-even analysis.
If you’re extending the term of your loan, understand that you may be lowering your monthly payments, but you will increase the overall amount you pay in interest. Conversely, lowering your term will increase payments, which could put added strain on your finances.
With cash-out refinancing, you’re putting your home equity nest egg at more risk with less protection if you suffer a financial setback. Refinancing doesn’t eliminate this risk and, in some cases, could even exacerbate it if the new loan terms are not manageable within your budget.
Are the Closing Costs of a Mortgage Refinance Worth It?
In most cases, the answer is yes, but depending on your specific situation, a better answer is that it depends.
Part of what you must do is calculate the break-even point at which you’ll be positive with your cash outlay vs. if you don’t refinance. Several sites offer mortgage refinance break-even calculators to give you a good idea of what you’re in for. You can also work with your lender, who will help you run numbers.
When you shop for a loan and receive a mortgage offer, review the three-page Loan Estimate form the lender provides. All lenders use this standard document, and it allows you to compare loan offers readily. In particular, look at closing costs and estimated expenses over five years in addition to the interest rate and APR.
Generally, financial planners advise you not to refinance unless you can lower your interest rate by a full percentage point or two. The Financial Housing Administration (FHA) won’t even let you streamline refinance one of its FHA loans if it doesn’t lower your monthly payment’s principal and interest by at least .05 percent.
You also must consider other reasons to refinance, such as if you need money for other uses or want to change the terms of your loan to a more favorable interest rate or loan length.