Closing costs are key parts of refinancing a home. The closing costs generally include appraisal fees, credit fees, lender fees, points, taxes and insurance, escrow and title fees. Understanding those costs and factoring them into your decision will enable you to know if refinancing will be truly profitable or advantageous to you. If you do not factor in all the possible costs before you make a decision to refinance, you may end up paying more for your home by refinancing even if you may be getting a lower interest rate. Refinancing your home is a decision based on multiple factors and for multiple reasons. In essence, refinancing your home is taking out a loan to pay off your existing mortgage, with you pocketing the difference between new loan and balance owed. As with the original mortgage, there are fees and costs associated with refinancing a mortgage. On average, these will total up to 3% to 6% of your outstanding principal. The most common costs and fees are closing costs, appraisal costs, and loan origination fees.
Closing Costs and Other Costs Definitions
To help you understand all the various fees, we have provided simple definitions for each of them below:
- Application fee: You may be responsible for this fee even if your loan is denied. Average cost $75-$300.
- Loan origination fee: Charged by the lender for your refinanced (new) loan. Usually 0-1.5% of loan amount.
- Appraisal fee: This fee is charged to determine the current value of your home. You cannot get a loan for more than the appraised amount. Usually $400-$700 depending on your area. You can generally keep a copy of the appraisal, just ask your lender.
- Inspection fee(s): Depending on your location, you may be required to get a termite inspection, mold inspection, structural integrity inspection and so forth. These inspections will range anywhere from $200 to $500 each.
- Closing fees/attorney review: Depending on where you live, either an attorney or a title agency will be required to review all the documents and confirm they are legally prepared. Anticipate 500 to $1000.
- Prepayment penalty: Depending on the terms of your original mortgage, you may have a prepayment penalty due, which can be as much as 6 months worth of interest payments.
- Points: This is an optional fee paid to a lender in order to reduce the interest rate over the life of the loan.
Why Refinance in Spite of the Closing Costs?
Simply put, it can be a solid financial decision. In fact, if you have enough equity in your home, you can even use the equity to pay off all the closing costs. In addition, drops in interest rates can reduce your monthly payments substantially, or reduce the amount you pay for your home over the course of the loan. You may want to move from an adjustable rate mortgage (ARM) to a fixed rate mortgage. You may want to change the length of your loan, either decreasing the time to pay off or increasing the length to reduce monthly debt. It’s important to understand the equity you have in your home and find out if it can easily cover your closing cost when refinancing.
To wrap up, closing costs are crucial parts of refinancing, but they shouldn’t discourage you from refinancing because refinancing may still be right for you even after factoring in the closing costs. If there is enough equity at the time of refinancing, the equity can even cover the closing costs and you can use the rest of the equity for other things, like paying off debt or investing.