What Does It Cost to Refinance?

With mortgage rates crashing through the floor like Arnold Schwarzenegger on a thatched roof, most of the Americans (68% of households) who own their own homes have either refinanced or thought about it. Now, a new trend toward fixed-price or guaranteed-price refis may help them better determine their costs and savings.

How much does it cost?
Lenders are required to provide you a Good Faith Estimate of your closing or settlement costs. True, there are some costs a lender doesn't know at the time you inquire, but the estimate has become more and more of a game in which costs look good when you are a prospective customer but mysteriously balloon at closing. Good Faith Estimates can omit substantial costs -- as much as 60% or more. Because a borrower's decision to refinance depends on balancing savings against costs, moving the cost ball is no fun.  

Help on the way
Last summer, the federal government proposed a new rule that would require lenders to offer rate and price information in a new Guaranteed Mortgage Package Agreement or the current Good Faith Estimate, subject to some tinkering. That rule is not yet final, but the lending industry isn't waiting around.

Responding to consumer demand, some lenders have developed what they call flat-fee, one-fee, or guaranteed-fee refinancings. Lenders such as Greenlight Financial Services, GMAC Mortgage and its Ditech.com affiliate, and ABN AMRO Mortgage's E-Loan subsidiary have reportedly closed tens of thousands of guaranteed price refis.

Roughly speaking, this product guarantees you that your closing costs will be X, which might include origination and discount points, fees for credit reports, wire transfers, document preparation (a haven for unnecessary fees), notaries, title company services, as well as lender-required pest inspection, title insurance, and appraisal. (Remember that you most likely don't want to pay points when refinancing. Check out An Insider's Guide to Refinancing to find out why and how to figure the tradeoff between rates and points.) 

Some fees won't be covered, such as local property and transfer taxes, mortgage insurance premiums, prepaid interest, and hazard insurance premiums. These are items that the lender reasonably doesn't know at the time of application, and they are not insignificant -- from a few hundred to over a thousand dollars. 

You can better identify the costs not included in your fixed-fee offer by pulling out your settlement documents from your last mortgage closing. Compare the items on your settlement statement to those listed in the guarantee. Add up those not included to find what your fixed-, one-, or guaranteed-fee refi will really cost you.

When you go loan shopping, ask each lender if it offers a guaranteed price refi. Get everything in writing, and don't sign anything you haven't read closely and that you don't understand. Remember that this is a sales business, and as with cars, real estate, and many other items, some salespeople will be helpful while others will try to avoid answering clearly and directly. Be comfortable or go elsewhere. 

When do you break even?
Once you know your costs, compare them to your estimated savings. Compare your current mortgage payment to a new one at a particular lower rate, using our handy mortgage calculator.

Caveat: You probably won't save the entire difference between your current payment and your estimated payment for a new mortgage. For most of you who itemize your tax deductions, a lower interest rate means you will be paying less interest (unless you get cash back and increase your loan amount), so you will have a smaller mortgage interest deduction come tax time and a corresponding increase in tax liability. This is no reason to skip refinancing, but just a reminder that thinking clearly about your real savings means considering the tax consequences of refinancing.    

Then you compare your savings to the closing costs for a rough idea of how long you have to own your home before you start saving. For example, if you save $200 a month and will pay $2,500 to refinance, your breakeven point is 12.5 months.

Some of you are saying, "But I got a no-fee refinance!" While this may save you out-of-pocket cash at closing, there is no such thing as a free lunch, er, mortgage. Lenders still collect their fee either by charging you a higher rate, rolling the fee into a higher mortgage loan amount, or both. And if you are getting cash back -- a cash-out refi -- you may well pay a higher rate, too, with new practices from Freddie Mac and Fannie Mae that the majority of lenders will likely adopt.

Always look at the whole picture when figuring cost versus savings.

Last word
There are people who are so crazed to get the lowest interest rate that they refinance at the drop of a shingle. Others may fear that the process is too complicated and lose the chance to save some money.

The best way is through the middle. Slow down and take your time. As with buying or selling stocks, you will never buy at the historic top or low, but sound research will lead to good investment decisions. Ditto with mortgage refinancing. Missing an interest rate quarter point here or there won't hurt you, but failing to act at all or jumping too soon without learning the details just might.

You can find help with all your real estate questions on our Buying or Selling a Home discussion board (30-day free trial to read; subscription required to post). For more information on everything from buying to maintaining your home, have a look at our Home Center.

Tom Jacobs (TMF Tom9) has owned three houses and refinanced mortgages as many times. He recommends a good pair of reading glasses so you can always read the fine print!