There’s No Such Thing as a No-Cost Mortgage

When interest rates are on the low side, you probably wonder whether it’s time to refinance your old mortgage. Generally, refinancing does save money. But don’t rush into it — you need to make a few calculations first.

It’s hard to come up with a calculation that fits everyone. Your savings depend on many factors, including the new interest rate, the length of the new loan, how much you’ve already paid down your current mortgage, your tax bracket and a myriad of up-front charges.

Don’t be fooled by claims of no-cost loans. There are always up-front costs, though they may be rolled into the mortgage payment.

So make some calculations based on this list of fees that you can expect to pay if you refinance:

• Origination Fee. This is the service fee, usually expressed as a percentage of the total mortgage. It can run as high as 2.5%, though 1% is closer to the norm.
• Discount Points. You pay these for getting the loan. One point equals 1% of the total loan, so three points on a $100,000 mortgage loan adds $3,000 to your refinancing charges. Generally, the lower the rate, the higher the points. Some lenders finance the points or offer zero points, but both maneuvers boost your monthly payments.
• Prepaid Interest. You’re likely to have interest from the date you settle until the end of the month. If you settle on November 10, you’ll have to prepay interest from November 10 through November 30.
• Escrow Accounts. These are required if your lender pays your homeowners’ insurance and property taxes. The lender sets up the account by adding the expenses to your monthly payments. They are kept in reserve until the bills are due.
• Miscellaneous. According to your situation, add in appraisal fees, credit report fees (the lender wants to be sure you’re still a decent credit risk), attorneys’ fees and application fees (which may not be refundable if you don’t go ahead with the refinancing). Also watch out for title search fees, title insurance, survey costs, hazard insurance and termite inspection fees. In addition, you may face charges for mortgage insurance, fees for a VA loan guarantee, FHA mortgage insurance or private mortgage insurance.

Now you’re ready to consider the interest rate and tax implications — the final steps to determine whether you’re going to be saving money. Important points here include:

• Recovery time. Estimate how long it will take to recover refinancing costs by dividing your closing costs by the difference between the new and old payments (your monthly savings).
• Dollar valuation. You want to take into account the future value of the dollar. (You’ll be paying up-front costs in current dollars but taking your savings in the future when the dollar may be worth less.) Savings will also be affected by the time you plan to stay in the home.
• Income taxes. Lower interest payments mean lower deductions. So you may wind up paying more taxes that gnaw away at any total savings. IRS rules generally force you to deduct points over the life of the loan, not in the year you refinance, unless they were paid in connection with the improvement of your home.

here you have it. One last warning: Check your current mortgage to see whether you’ll be charged a prepayment penalty. That can dramatically affect your savings.

Even if you decide refinancing isn’t worth it, you might want to ask your lender to alter some of the terms of your current loan. You may also want to talk to a tax or financial advisor for suggestions on what might better serve your needs.