What is the Cost of Refinancing?
Cost of Refinancing means the various costs incurred in the process of replacing an existing debt obligation with another debt under a new set of terms. This can be an effort to reduce EMI, lower interest rates, take cash out of home for large purchases or change mortgage companies for some or other reason.
Refinancing occurs when an individual or an organization revises its terms of finance, including repayment schedule, rate of interest, credit, etc; which will usually be opted when refinanced loan is available at a lower rate of Interest or higher maturity period with similar net cash outflows and this involves various costs known as refinancing cost which usually includes appraisal cost, title search, application fees, etc and generally runs between 2% – 4% of the total loan amount.
The terms and conditions of refinancing may vary widely by country, or state, based on several economic factors.
Types of Cost of Refinancing
#1 – Refinance Through Cash-Out
In cash-out refinance, the borrower can use the equity built up to get cash. It is a new loan for the amount of mortgage. Apart from this, it also includes cash received that would be up to 80% of the loan-to-value ratio.
#2 – Refinance Through Home Equity Loan:
A home equity loan is also known as the second mortgage. It is a separate mortgage. With home equity loans, the borrower can take up to 80% of the loan-to-value ratio.
#3 – Rate and Term Refinance:
It’s a typical mortgage refinance. The main purpose is to take benefits of the revised low-interest rates and new loan term based on new criteria.
#4 – Refinance Through Streamline:
Government-backed home loans are available for streamline to refinance. The processes of such refinance are usually very quick and easy.
Cost of Refinancing Formula
It is the summation of closing cost and fees wherever applicable.
Scenario 1: Closing costs and various fees are involved.
Cost of Refinancing Formula = Closing cost + (Escrow & Title Fees, Points, Taxes, Appraisal Fees, Lending Fees, Insurance Fees, Credit Fees, etc.)
Scenario 2: Closing costs are borne by the lender and various fees are involved.
Cost of Refinancing Formula = Escrow & Title Fees + Points + Taxes + Appraisal Fees + Lending Fees + Insurance Fees + Credit Fees etc.
Cost of Refinancing Example
Suppose, Mr. Bill has taken a mortgage loan and thinking of refinancing it. We have the below information:
Points calculation:
In the above example, the total cost of refinancing = Points + Closing cost
=$(2,295.72+1200) = $3,495.72.
Components of Cost of Refinancing
The cost of refinancing can vary depending on the interest rate of the loan, credit score of the borrower, relationship with lender and amount of loan. There are various components of Cost of Refinancing:
- Closing Cost – It is usually some percent of the outstanding amount of mortgage.
- Title Fees and Escrow Fees – It includes both owner and lender policy for the clause of title insurance and the escrow fee. They also include courier fees, miscellaneous drawing, a recording fee, the office’s fee, mortgage document notarization fees, and the notary’s fee.
- Appraisal Fees – Appraiser charges these fees for the critical inspection of the property be it an investment property or owner-occupied.
- Lending Fees – The lender charges these fees to process a mortgage. It is also referred to as garbage fees. These fees include underwriting, document preparation, processing, funding fees, administrative fees, wire, flood certifications charges, and tax service fees.
- Points – Point is a combination of discount fees and origination fees. Discount fees are prepaid interest down paid by the homeowner and are beneficial for the reduction in interest rate. Origination fees also reduce the interest rate, but they are mainly used to compensate for an originator during the complete transaction. One point usually equals to 1% of the total amount of mortgage.
- Taxes – Property taxes as agreed upon on a yearly or half-yearly basis. Other outstanding property taxes must be paid and cleared off at the time of first mortgage closing.
- Credit Fees – It is the fees to review the borrower’s credit report to assess the overall credibility in the particular timeframe.
- Insurance Fees – The borrower’s home insurance policy should be up-to-date at the time of the deal. It usually should not be less than 4 months. The standard coverage required by the lender is equivalent to replacement cost coverage.
Advantages of Cost of Refinancing
- Reduction in the interest rate of the mortgage. Combine with an increased credit score, people can procure loans at lower rates. It impacts monthly payments as well.
- Many people refinance in order to obtain money. It can be used for various purpose like purchasing a car, reducing credit card debt, etc. This can be done by taking equity out of the home.
Disadvantages & Limitations of Cost of Refinancing
- For borrowers with a perfect credit history, refinancing can be a good way to convert a loan to obtain a lower interest rate. Refinancing can be risky for borrowers with bad credit history, or with too much debt.
- There could be penalties incurred in the cost of refinancing which could be thousands of dollars.
- Refinancing cost may include paying for an attorney and bank fees which can ultimately not be a worthy affair.
Important Points
- Borrowers must maintain their first and original mortgage for at least 12 months before refinancing as most banks and lenders mainly check for the criteria to be fulfilled before proceeding. Also, the borrower must check the lender for the knowledge of all possible restrictions.
- Borrowers looking for refinancing may get numerable offers by different lenders but sometimes he may get best interest rate staying with the original lender.
- Interest rate environments are cyclical and impacts new credit and credit refinancing. National monetary policy, economic cycle, and market competition can fluctuate interest rates for consumers and businesses.
Conclusion
We can conclude that the cost of refinancing includes many fees and closing costs. It is always important to shop around for low or free refinancing. It’s worth considering saving thousands of dollars against wrong refinancing while getting a new line of credit.
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