In the past, refinancing meant balancing the benefit of lower monthly payments against the cost of refinancing. Traditional refinancing was laden with so many fees, that the out of pocket expenses made it unaffordable even to those people who would benefit from refinancing. These days, many lenders offer low- or no- fee financing to people with very good credit. For the rest of us, there are still some fees associated with refinancing a home loan.
Refinancing fees are the same as those associated with financing the initial purchase of the home: legal fees; application fees; and settlement costs. Additionally, with a re-finance, there might be pre-payment penalties and points to pay. The fees typically equal between three and six percent of the total amount of the loan, and since the fees associated with refinancing a home can add up quickly, many mortgage companies will waive the application and legal fees. This can save thousands of dollars, but can also result in a higher interest rate on the loan.
Pre-payment penalties are fees the lender charges you for paying off your loan early (which is exactly what happens to the original loan when you refinance). Why would a lender charge you for paying off your loan early? Lenders don’t make money on interest, and the shorter the loan term, the less interest they make. If you pay the loan off early, they miss out on a lot of interest they expected to receive from you. To offset their loss, they charge you hefty fees.
Points are often required by lenders and are paid at refinance closings. Points are like pre-paid interest, equivalent to usually one percent of the total amount of the loan. Points lower the interest rate on the loan and, with a regular loan closing, can be immediately deducted from income taxes. In the context of a refinance, the I.R.S. will not let you deduct the points right away; you must amortize them instead. That’s not a fee or tax hit per se, but it is a little something that borrowers don’t often expect. However, many lenders these days offer zero point closings for refinancing, so the buyer saves some money there and the tax point is moot.
One way to cover the fees associated with refinancing is to do a cash-out refinance. In this scenario, the home owner converts some of his equity in the home to cash that can be used for any purposes including paying the costs of refinancing. If the homeowner’s credit is good, he or she still may be able to lower the mortgage interest rates.