Refinance Closing Costs and the Bottom-Line with Break-Even Analysis

The following refinance closing cost analysis information should give you the tools that you need to determine whether the cost of refinancing will create a financial benefit for you, or not. The best part is that the analysis is pretty simple and can help with your refinancing decision.

You can avoid missing out on a refinancing deal that can reap significant financial benefit, because closing costs appear too expensive at first glance. Likewise, you can steer clear of a refinancing scenario where the cost-of-closing relative to bottom-line benefits are not in your best interest.

Your Refinance Closing Costs Are Too Expensive! Or Are They Really?

Often times, a refinance home loan shopper will take one look at the good faith estimate closing costs total for their rate quote and shriek the phrase "That's Too Expensive!"

"Dear Mr./Ms. Lender, you mean to tell me that it will cost several thousand dollars to refinance? Well, you can forget it, and please don't call me again!" Before Mr./Ms. Lender has a chance to go over the bottom-line benefit and financial impact, the Borrower slams their phone down in disgust uttering what a crook that Lender is.

It's important to get over that initial feeling that closing costs are a rip-off, before you have a chance to review the bottom-line numbers in conjunction with your loan timeframe. Several thousands of dollars for closing costs may scare you away from making a smart deal where the cost of refinancing will pay for itself, plus return an additional significant financial benefit over the term that you plan to hold your new mortgage.

All you need are the bottom-line numbers from Mr./Ms. Lender, timeframe that you plan to stay in your new mortgage, and an objective mind to make your decision. With this, you will have the power to pass on a deal that brings little or no benefit, or make a confident decision to move ahead with a refinance loan that results in a significant financial gain for you.

Refinance Closing Costs and
Break-Even Analysis Formula

  Closing Costs from Good Faith Estimate to Include for Break-Even Analysis

Subtract any estimation for property tax escrow deposits, homeowner's insurance (and homeowner's association dues if applicable) escrow deposits, and pre-paid interest estimations.

You are now left with the true "Bottom Line" closing costs total by adding the remaining expense items from the good faith estimate.

Refinance Closing Costs Break-Even Formula:

"Bottom Line Closing Costs Divided By Monthly Savings = Break-Even Point"

Say for instance that your total Bottom Line closing costs amount to $6,600 and by refinancing into your new loan, your monthly mortgage payment will decrease by $275. Divide the $6,600 by $275 and your resulting Break-Even Point is 24 months.

So, in 24 months, the closing costs will be paid for and the borrower will receive a net benefit of $275 per month thereafter. Yes, it's that simple!

Timeframes and Bottom-line Benefit

You know what they say about making money with real estate . its Location, Location Location!

Well, with refinancing your mortgage . its
Timeframe, Timeframe, Timeframe!

Your Timeframe is the length of time that you plan to stay in your new mortgage.

Lets take a look at an example:

Suppose you want to refinance your first mortgage (current 30 year fixed 6.5% with $150,000 balance) and second mortgage (current 30 year fixed 8.25% with $50,000 balance) into one new home loan at a lower rate and payment. The principal and interest (P&I) monthly payment on your current 1 st mortgage is $1,100 and $450 for your 2 nd mortgage for a total P&I monthly payment of $1,550.

You want to refinance into a 5.0% 30 year fixed rate and the bottom line closing costs amount to $6,500 (closing costs) with an additional $3,500 (settlement costs) for escrow deposits and prepaid interest. You are rolling-in the closing and settlement costs into your new loan amount.

Your total new loan amount would be $210,000 ($150,000 1 st mortgage balance plus $50,000 second mortgage balance plus $10,000 closing and settlement costs).

Your new monthly P&I payment would be $1,128 ($210,000 new loan amount at 5.0%).

Your total monthly savings would be $422 ($1,550 old payments minus $1,128 new payment).

Your Break-Even Point for closing costs is 15.4 months ($6,500 bottom-line closing costs divided by $422 monthly savings)

Now here's where your timeframe comes into the picture. If you think that you may move or refinance in a couple years, it may not be worth your time to refinance now, but if you plan on staying in your new mortgage for a longer term, then look at the net benefits AFTER deducting $6,500 for closing costs.

At first glance, the $6,500 for closing costs may have seemed excessive, but as you can see by the example, it's a drop in the bucket compared to the total loan benefit.

To calculate your long-term net savings after deducting for closing costs, simply multiply the number of months by monthly savings and subtract Bottom-Line closing costs.

Using the preceding example, 5 year net savings is $18,820 (60 months x $422 monthly savings - $6,500 closing costs). 30 year net savings is $145,420 (360 months x $422 monthly savings - $6,500 closing costs).

Rolled-In Closing Costs and
Other People's Money

Although there are no specific statistics as to the percentage of homeowners that roll closing costs into their new mortgage, it is safe to assume that most do just that.

Rolled-In-Closing-Costs are an often-overlooked benefit of a home refinance for those who plan to stay with their new mortgage long-term. It's an incredible advantage for a homeowner to use "Other People's Money" (namely the lender's money) to fund a significant financial benefit for them.

Wealthy individuals and businesses use this strategy all the time. Borrow funds for the longest period of time at a low interest rate and use that money to create profits.

Why shouldn't the average homeowner use the same strategy? Borrow funds for the longest period of time (namely 15 to 30 year mortgages) at a low rate of interest to create savings (profits).

In fact, the only out-of-pocket expense for most refinancing homeowners is just for the cost of their home appraisal.

Citing the preceding example, an individual that blindly states that closing costs are too expensive and puts a halt to the refinancing plans, will be making a huge financial mistake (an $18,820 mistake) if he or she plans to stay in their home for at least five years, and a $145,420 mistake over the term of the loan!

Don't be that individual! You now know how to calculate your break-even point for closing costs and can extend your projected savings total to the term that you plan to stay with your new mortgage. You would be selling yourself short and lose the chance to potentially save tens of thousands of dollars, by blindly rejecting a refinancing opportunity based on the closing cost figure quoted.

A few minutes spent calculating could bring you a windfall of savings in return, or show you that a particular program is not in your best interest at the moment.

Discount Points

Discount Points are of huge concern to many refinancing home loan shoppers, so lets discuss what they actually are, and how they figure into closing costs.

Discount Points are paid for by the borrower to "Buy-Down" their interest rate, and are included in the "Lender Fee" portion of closing costs. 1 discount point equals 1% of the total loan amount. So, for a $200,000 loan amount, using 1 discount point to Buy-Down your rate will add $2,000 to closing costs. Discount Points can make great financial sense for those that plan to stay in their new mortgage for the long term, because the additional monthly savings gained by lowering the interest rate will pay for the discount point fee over time, then produce a free-and-clear gain thereafter.

Another benefit of using the Break-Even analysis method, is that you don't have to worry about how many discount points are being applied for your desired interest rate. The Bottom-Line savings figure in conjunction with your loan timeframe will reveal your net benefit.

You can compare, say a 5.5% rate with lower closing costs against a 5.0% rate with higher closing costs to reveal your bottom line savings for each program. Then you can make a confident decision on which refinance program is best for you, based on the number of months you plan to stay with your new mortgage.

It doesn't matter whether the 5.5% program has no points and the 5.0% program has 1 point or 3 points, because the Bottom-Line numbers will paint the picture. If your timeframe is short, the 5.5% rate may be the way to go, longer timeframe, and the 5.0% option may be the most beneficial fit.

Many refinancing homeowners focus almost solely on how many discount points are included with their rate quote because a friend, neighbor, or co-worker told them that points are a rip-off, but you now know differently.

Who cares how many discount points are included with your rate quote? Your Timeframe and Bottom-Line Savings is all that really matters. Remember, if you are rolling-in your closing costs, you are using Other People's Money to finance your long-term gain, which makes those pesky discount points that were once viewed as a rip-off, now appear as a golden goose.

In many instances, due to closing costs, refinancing homeowners will "Freeze" when it comes time to apply for their loan and lock their rate. For some, they just cannot get over the fact that it will cost several thousand dollars to refinance into a new mortgage, even though the numbers reveal a fantastic financial opportunity.

This happens virtually every day, so we'll share a recent example.

A borrower with a minimum 10 year time frame called for a rate quote and wanted to refinance out of a 6.75% $275,000 30 year fixed loan, into a new 30 year fixed mortgage at a lower rate. The borrower has excellent credit and an LTV under 80 percent, so a 4.5% program was available with total bottom line closing costs of $6,720. With all closing costs rolled back into the new loan (no money out of pocket for closing costs), the net monthly savings would have been $350 per month. The borrower declined, stating that closing costs were too high and that he would just stay-put with his current mortgage.

The borrower's breakeven point is under 20 months and net savings (after deducting for closing costs) for the 10-year time frame is $35,280 and $119,280 for the term of the loan!

The answer was still "No" to the new loan. His focus was solely on the closing costs figure and "Froze" his decision for what would appear as an excellent financial opportunity.

Now, we do a thorough pre-qualification, and knew that the borrower was in his current loan for 3 years. With this information, a whole new crop of benefit opportunity arises.

He could do a Bi-Weekly repayment option, reducing the term of the loan by greater than 4 years and keep all the savings.

He could prepay the $350 monthly savings amount and knock 10-years off the term of the loan, or he could simply just pocket the savings, invest, or go on a spending spree!

A great refinance opportunity with plenty of benefit options and no out-of-pocket expense (except for the appraisal fee) lost because of a sole focus on closing costs.

Sometimes homeowners forget that refinance closing costs are what allow borrowers to finance their benefit opportunity in the first place.

Although they may amount to several thousand dollars, closing costs can be one of the best deals on the planet to leverage up to tens of thousands of dollars in net benefit for the homeowner.

More Reasons Why People "Freeze"
in Making a Refinance Decision

Human Nature is Holding Me Back

Another common reason that people "freeze" when it comes time to apply for a refinance loan can be attributed to human nature. It is human nature to want to keep things the same or to "Stay-Put", even when an advantageous opportunity arises. Becoming aware of this subconscious method of reasoning can help some to pull the trigger and take the beneficial deal.

Financial News Says Rates will Drop Further

I'm waiting for rates to drop further! This is a mortgage industry classic response, and oddly enough, becomes more common when rates are already at their lowest historic levels. A homeowner can be staring at a current great rate and fee program right in the face, take those "in-hand" significant benefits, and throw them to the wayside, in hopes that rates will drop further. Could this be a flash of "human nature" entering the decision-making process?

Many homeowners will get hooked into the latest financial expert reports on CNBC or CNN stating that mortgage rates will come down further in the coming months. What the viewer may not know is that these same "experts" reported that rates were going up to 8 percent in the fall of 2008, right before rates dropped to 5 percent. The truth of the matter is, no one can tell, with any degree of certainty, where rates will go. Those that try to "time" the interest rate bottom, will most likely end up panicking into a higher-than-current interest rate or not refinance at all.

A good way to look at it is whether you are willing to risk an "in-hand" significant benefit for hopes that the deal could get a little better by waiting. How much lower can rates really go from current levels? If I have to wait 6 months, 1 year, 2 years, or not refinance at all, how much would my current "in-hand" benefit add up to? If I wait 1 year for rates to drop one-quarter point, will it make up for the year's worth of savings lost?

Most people that have a current beneficial refinance opportunity and truly reflect upon the previous "what if" scenarios, realize that the risk is not worth the reward, and will lock their rate while the getting is good. Most will also find, that once a decision is made to move ahead with their loan, they will experience a sense of peace that they made the proper decision.

Too Good to be True

Another conscious or subconscious reason that homeowners "freeze" when it comes time to apply for a loan and lock their rate is the feeling that the loan benefit stated sounds "too good to be true". It seems too easy and there must be something else that is not being disclosed.

This is common, especially when rates are low and a borrower is refinancing large loan amount into a lower fixed rate, a 1st and 2nd mortgage into one lower fixed rate, or consolidating credit cards and other installment loans with their current mortgage into a lower fixed rate. The monthly savings can be quite astounding and may seem almost too good to be true.

The numbers will not lie. As long as you are working with a loan officer that performs a thorough pre-qualification, and follows-up with an underwriting pre-approval process, before you commit to your rate lock, you should feel confident with the numbers presented. That "too good to be true" feeling will evaporate while dealing with a competent mortgage professional and reputable lender company.

Closing Costs will Change: Lender Trust

A "fear" that some refinancing homeowners encounter is that closing costs will change from their initial good faith estimate to the time that the new mortgage is ready to go to closing. This feeling will cause many to put the "freeze" to any refinance plans.

Let's face the facts. The mortgage lending community has not exactly exuded the face of confidence and trustworthiness for consumers in recent times. The old "bait and switch technique, fast-talking loan officers, and outright shoddy loan pre-qualifications have caused many potential refinance borrowers to distrust any lender, period. This is understandable, and an unfortunate part of the current refinance lending environment.

One way that you can avoid a trust issue, particularly when you expect your locked refinance program particulars to stay the same from lock to close, is to utilize the services of a third-party certified "Upfront Mortgage Lender". With a third-party certified Upfront Mortgage Lender, you are assured a fair and accurate interest rate and closing cost quote. You will receive guaranteed closing costs in writing and your locked refinance program will not change.

If you are unsure who you are dealing with, simply ask your loan officer if they are a certified "Upfront Mortgage Lender" and where you can verify the designation on their website. This should give you the assurance you need, to be sure that your quoted closing costs and rate lock will not be changed mid-stream during your loan process.

Gut Check Time

So you've contacted a lender, received a thorough pre-qualification with your quote, done your breakeven analysis, show a savings/benefit, and its decision time whether to apply and lock your rate, or not.

This is really one of the most difficult parts of the loan process for a refinancing homeowner. Only you can decide whether your refinance benefit meets your goal and timeframe.

You now know how to calculate the "Bottom-Line" for your loan scenario, who to trust for fair and accurate treatment, and the major conscious and subconscious barriers that cause borrowers to "freeze" at application time.

You know that having a significant beneficial refinance program "in-hand" now, but waiting for rates to drop further can cost you dearly in the long run. Those who try to "time" the mortgage rate market bottom seldom end up with a better deal than the one currently available to them, especially when interest rates are at or near historic lows. You know that the risk of waiting outweighs the potential reward of a future drop in rates when you are currently staring at a big benefit.

You also know that by rejecting refinance plans based solely on closing cost numbers alone, you could stand to lose out on thousands to tens of thousands of dollars in savings for your specific loan time frame. You know that closing costs typically pay for themselves many times over, and offer an added benefit when rolled-in to your new loan because you are using "Other People's Money" to finance your beneficial new mortgage loan.

You can now avoid being one of those homeowners that agonize and delay over the decision to lock now, or wait for a better deal, time, year, or decade. Just like successful business people and many wealthy individuals work, you will base your decision to refinance now based on facts/figures and risk/reward and take action decisively one way or the other and be confident in your decision.

You are Ready!

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