Refinancing your home mortgage to a lower rate can save you a lot of money over the long term and ease your budget every month with a lower house payment, but it might cost you to get there. Closing costs on a new refinance mortgage can add up to thousands of dollars, making it tougher to reap the benefits of the lower rate. However, you can implement one or more tactics to reduce the size of the check you need to write when closing on a new home loan.
Many lenders and finance agencies such as the Federal Housing Administration and Department of Veterans Affairs, offer streamline refinance programs. With a streamline, if the only purpose of the refinance is to reduce your interest rate, the qualification requirements and some of the closing costs are reduced. If you have an FHA or VA loan, you might qualify for a streamline refinance with another lender that participates in the government insurance programs in order to shop for lower closing costs. If your loan isn't FHA or VA guaranteed, start your search for a lower-cost refinance with your current lender.
Increased Loan Amount
To reduce the out-of-pocket expense of closing costs that come with refinancing, roll some or all of the costs into the new loan balance. For example, if your existing loan balance is $200,000 and the closing costs for a new loan are $6,000, you can take out a new loan for $206,000 to cover the payoff of the existing loan balance and the costs of getting a new, lower-rate mortgage. This option requires that you have enough equity in your home for the lender to approve the higher loan amount.
Higher Interest Rate
Another way to produce some cash to cover closing costs is to get money back from the lender by accepting a slightly higher interest rate for your new loan. With a higher rate, the lender will pay negative or refund "points". One point equals 1 percent of the loan amount. For example, if the lender's regular rate is 4.5 percent, by taking a 4.75 percent rate on the loan, you'll get 1.5 refund points. On a $200,000 loan, the 1.5 percent equals $3,000 toward reducing the closing costs. If you're refinancing from a much higher-rate mortgage, accepting an increased rate in exchange for points can still save you money each month.
After consulting with a loan officer about ways to structure a loan to refinance your current mortgage, examine options with varying rates, refund points, loan amounts, closing costs and monthly payments. Divide the closing costs by the amount your monthly payment will be reduced with the refinance. This tells you how long it will take to recover the refinance closing costs. Also, calculate the total savings over the life of the loan by multiplying the monthly savings, the number of payments compared to your current payment and the number of remaining payments.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.