Budgeting Essentials
Why a Low Interest Rate May Not Be a Good Deal
Mortgage and home refinance loans generally last from 15 to 30 years. Before you leap for a low rate, here are some things to consider.
Whether you are buying or refinancing, you may be feeling that the biggest challenge is finding a low interest rate. You might ask, “What else should I know before signing loan documents?”
The answer to this question is: Plenty!
One of the biggest hurdles many people experience is remembering that folks in the lending business are in the business – first and foremost – to make money. Seldom will you encounter a person who will talk you out of taking a loan with them. Why? These people earn their “paycheck” when you agree to borrow money from them.
So, what’s the big deal? You ask. I’ve found a lower interest rate. Isn’t that all there is?
No.
Before you carry on countless conversations via telephone or text, you will need to do your homework. For example, what are closing costs?
What are Closing Costs?
The typically short answer may sound like this:
“Oh yeah. Closing costs are the fees you will pay any lending institution when you borrow money. Don’t worry, they’re all about the same.”
Lending Tree’s article entitled, Understanding Mortgage Refinance Closing Costs (written by: DENNY CEIZYK, and updated on April, 11, 2023) reports that there is no established formulary for calculating refinance fees. Some costs do fluctuate between lenders.
In terms of percentage points, this article states that you can expect to pay between 2% to 6% of the loan amount, depending upon how much you borrow. It is wise to consider the percentage differences on your own loan amount. For example, let’s say that you want to
borrow or refinance in the amount of $400,000.
$400,000 x 2% = $8,000
$400,000 x 6% = $24,000
Now, that is a big difference, isn’t it? $16,000 different.
We suggest you read the Lending Tree article as it also discusses:
What are mortgage refinance closing costs?
How much are refinance closing costs?
How much should you pay for refinance closing costs?
Factors that could impact conventional refinance closing costs in 2023
10 ways to reduce your refinance closing costs
What about no-closing-cost refinances?
Another item you will want to consider is: Keeping your loan term the same.
Keeping Your Loan Term the Same
If you have 15 years left on your home loan, it would be in your best interest to keep your loan term the same if you are going to refinance the loan. Why?
Let’s say that your current mortgage interest rate is 9%. You have found a lower interest rate of, say, 5.9%. So now you are refinancing a 15-year loan into another 15-year loan with a 3% lower interest rate. Aside from the closing costs involved in this loan, your monthly payments are *likely to be less.
Consider this: if you have 11 years left on your mortgage and refinance into a 15-year loan, you may begin to lose the benefit of the lower interest rate. Not only are you paying longer, you are paying additional interest over that extended 4 years. Additionally, you may be tempted to consolidate student loan and credit card balances into this 15-year term and that may not be in your best interest. Before you do this, please consult with your CPA or financial specialist who can help you decide.
Let’s discuss the *likely-to-be-less factor next.
This is where you also consider the annual percentage rate (APR) of your new loan against the APR of your current loan. Why is this important?
It matters, because the APR includes the additional expenses you will pay. In our example above, you found an interest rate of 5.9% - which sounds like a good deal, right? The next step is to look at the documents that show your APR.
Low interest rate: 5.999%
APR: 6.898%
The difference between your low interest rate and the APR is just shy of 1%. The difference may seem low, but these costs add up over 15 years.
On your Closing Disclosure statement toward the bottom of the page, you should find a section entitled “Costs at Closing”. I want you to pay particular attention to both the Closing Costs listed and the Cash to Close.
Remember the article mentioned above that stated you could expect to pay between 2% and 6% of the loan amount?
Here is how you figure that out:
Take your total closing costs and divide that number by your total loan amount.
The answer you get is the percentage of closing costs you are paying.
Example:
You are borrowing/refinancing $400,000.00
Your closing costs amount is: $ 41,746.40
41,746.40/400,000 = 0.104366 = you are paying 10.4366% of your loan amount for closing costs. A far cry from 2% to 6%, wouldn’t you say?
The next thing I want you to do:
Take the Cash to Close amount and divide that by your total loan amount.
Your Closing Costs amount is: $41,746.40
Your Cash to Close amount is: $ 8,504.70
8,504.70/41,746.40 = 0.20372296 = you are paying 20.37% down on your closing costs to close this loan.
Of course,sthis is not an all-inclusive list. Hopefully, it is enough to get your “protect my money” juices flowing. Also, go ahead and examine the article from Lending Tree in the link above. Focusing on the details will put you a step above when it comes to dealing with your lender or comparing one lender to another. We wish you well!
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