Refinancing can save you significant money each month depending on how much your interest rate is reduced. Unfortunately, refinancing isn't free. You must pay closing costs, the fees charged by your lender and third-party service providers. You might also have to pay to fund an escrow account that your lender will tap to pay your homeowners insurance and property tax bills. Depending on your timing, you might be able to roll most of these costs into your monthly mortgage payments when you refinance. Instead, then, of having to pay thousands of dollars upfront in one lump sum, you can pay these costs over the life of your loan by making slightly higher monthly mortgage payments.
The Federal Reserve Board estimates that it could cost you from 3 percent to 6 percent of your outstanding loan balance in lender and third-party closing costs to close a refinance. If you are refinancing $200,000, you can expect to pay from $6,000 to $12,000 in closing costs. Some of these costs come from your lender, which charges you for preparing your loan documents, verifying your income and debts and making sure that you are financially healthy enough to afford a mortgage payment. Other fees are charged by third-party companies for everything from termite inspections and home appraisals to title searches.
Your lender might require you to set up an escrow account. This means that you'll send in extra money with each mortgage payment. Your lender will funnel this money into an account and use the funds in it to pay your property tax and homeowners insurance bills. Under such an arrangement, you are not responsible for saving the money to pay these bills. You're also not responsible for remembering to pay them on time. How much you pay into escrow depends on your insurance premiums and property taxes. If you owe $6,000 total for these two bills each year, you'll have to pay at least $500 extra each month with your mortgage payment. Lenders are allowed to collect a cushion of two months worth of extra payments throughout the year to make sure that your account always has enough money to cover these bills.
Rolling Closing Costs
You can usually roll your closing costs into your monthly mortgage payments when refinancing. This saves you from having to come up with thousands of dollars at the closing table. Instead of paying, say, $10,000 in closing costs in one lump sum, you add that $10,000 to the total amount of money you are refinancing. Your monthly mortgage payments increase slightly, and you pay back your closing costs over the length of your loan.
Rolling escrow accounts into your monthly payments after a refinance can be more complicated. It all depends on timing. Your lender will routinely roll your escrow payments into your monthly mortgage payments. But if your property tax and homeowners insurance bills are due soon after you refinance -- say within one or two months -- you might have to bring money to the table to cover these bills. That's because if you refinance with a different lender, you won't be able to simply transfer the funds already in your existing escrow account into your new account. Instead, you'll have to wait -- and this can take up to 45 days -- for your lender to send you a check for the balance in your now-closed escrow account. This is why it often makes sense to refinance after your property taxes and homeowners insurance payments have already been paid. If you don't do this, your lender might have to add the money it needs to pay your property tax and homeowners insurance bills to the amount you are refinancing. You'll then have to pay a slightly higher mortgage payment each month to pay these costs off throughout the life of your loan.
There is a downside to rolling closing costs and escrow payments into your refinance: You'll be paying off these costs for 30 years if you pay your loan off in full. This will result in mortgage payments that are slightly higher. For instance, if you are refinancing $200,000 into a 30-year fixed-rate loan with an interest rate of 4 percent, your monthly payment of principal and interest will be about $954 a month. If your closing and escrow costs come out to $12,000 and you roll them into your loan, you'll now be refinancing $212,000 into a 30-year fixed-rate mortgage loan at the same interest rate. Only now your monthly payments will increase to about $1,012 a month, an increase of about $58 a month.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.