Refinancing a mortgage loan to one with a lower interest rate can save you hundreds of dollars a month, but trying to do this just one month after you purchase a home might cost you money instead of saving you dollars. Even if it doesn't, the odds are low that you'll have enough equity to be able to refinance your mortgage loan so shortly after taking it out.
Many lenders charge their borrowers prepayment penalties if they pay off their mortgage loans too early. These prepayment penalties vary by lender, but they usually kick in if you pay off your home loan within three to five years of taking it out. Refinancing your mortgage loan counts as paying it off; when you refinance you are closing one loan and taking out a new one. Prepayment penalties aren't cheap, usually running from 2 percent to 4 percent of your outstanding loan balance. If you owe $200,000 on your loan, for example, a prepayment penalty could cost you from $4,000 to $8,000. This extra cost might eliminate much of the savings you'd receive from refinancing.
Refinancing isn't free even if you don't have a prepayment penalty attached to your mortgage loan. Your lender and third-party providers such as home inspectors and appraisers will charge you fees to close a refinance. The Federal Reserve Board estimates that it will cost you from 3 percent to 6 percent of your outstanding loan balance to refinance a home loan. If you owe $200,000 on your loan, that comes out to $6,000 to $12,000 in closing costs.
To make a refinance worthwhile after such a short time, you'll need to significantly lower your interest rate. If you're paying off a 30-year fixed-rate mortgage loan of $200,000 with an interest rate of 5 percent, your monthly principal and interest payment on that loan will be about $1,073. If you refinance that $200,000 loan balance to a 30-year fixed-rate loan with a lower interest rate of 4.25 percent, you'll have a monthly principal and interest payment of about $983 -- a savings of about $90 a month or $1,080 a year. If your closing costs are $6,000 and your prepayment penalty adds another $4,000, you'll pay $10,000 to close this refinance. It will then take you more than nine years at a savings of $1,080 a year to pay back these costs. That's a long time to wait to make a profit.
Even if you want to refinance a month after buying your home, you might not be able to. That's because most lenders require that you have at least 20 percent equity in your home before they'll let you refinance. If you made a down payment of less than 20 percent of your home's purchase price, the odds are -- unless home values have skyrocketed in the month since your purchase -- that you won't have enough equity to qualify for a refinance.
- Federal Reserve Board: A Consumer's Guide to Mortgage Refinancing
- Bankrate: 6 Steps to a Lower Prepayment Penalty
- PrimeLending. "Types of Refinance Loans." Accessed April 28, 2020.
- Freddie Mac. "Working With Your Lender to Refinance Your Loan." Accessed April 28, 2020.
- Consumer Financial Protection Bureau. "Request Multiple Loan Estimates." Accessed April 28, 2020.
- Consumer Financial Protection Bureau. "Is There Such Thing as a No-cost or No-closing Loan or Refinancing?" Accessed April 28, 2020.
- Freddie Mac. "Costs of Refinancing." Accessed April 28, 2020.
- Redfin. "What Is a Yield Spread Premium?" Accessed April 28, 2020.
- Consumer Financial Protection Bureau. "Should I Refinance?" Page 2. Accessed April 28, 2020.
- Wells Fargo. "Thinking About Refinancing?" Accessed April 28, 2020.
- Citi. "Thinking of Refinancing?" Accessed April 28, 2020.
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.