What is the Cost of Refinancing?

Refinancing occurs when an individual or an organization revises its terms of finance, including repayment schedule, rate of interest, credit, etc.; which will usually be opted when the refinanced loan is available at a lower rate of interest or higher maturity period with similar net cash outflows and this involves various costs known as refinancing cost which usually includes appraisal cost, title search, application fees, etc. and generally runs between 2% – 4% of the total loan amount.

The terms and conditions of refinancingRefinancingRefinancing is defined as taking a new debt obligation in exchange for an ongoing debt obligation. In other words, it is merely an act of replacing an ongoing debt obligation with a further debt obligation concerning specific terms and conditions like interest rates tenure.read more may vary widely by country, or state, based on several economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others.read more.

Types of Cost of Refinancing

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Cost of Refinancing (wallstreetmojo.com)

#1 – Refinance Through Cash-Out

The borrower can use the equity built up to get cash in cash-out refinanceCash-out RefinanceCash-out refinance (COR) means taking a new mortgage loan of higher value to close the old mortgage loan and receiving the difference as cash. read more. It is a new loan for the amount of the mortgage. It also includes cash received that would be up to 80% of the loan-to-value ratio Loan-to-value RatioThe loan to value ratio is the value of loan to the total value of a particular asset. Banks or lenders commonly use it to determine the amount of loan already given on a specific asset or the maintained margin before issuing money to safeguard from flexibility in value.read more.

#2 – Refinance Through Home Equity Loan

A home equity loan is also known as a second mortgage. It is a separate mortgage. With home equity loans, the borrower can take up to 80% of the loan-to-value ratio.

#3 – Rate and Term Refinance

It’s a typical mortgage refinance. The main purpose is to take benefits of the revised low-interest rates and new loan terms based on new criteria.

#4 – Refinance Through Streamline

Government-backed home loans are available to streamline refinance. The processes of such refinance are usually very quick and easy.

Cost of Refinancing Formula

It is the summation of closing costs and fees wherever applicable.

Scenario 1: Closing costs and various fees are involved.

Cost of Refinancing Formula = Closing cost + (Escrow & Title Fees, Points, Taxes, Appraisal Fees, Lending Fees, Insurance Fees, Credit Fees, etc.)

Scenario 2: Closing costs are borne by the lender and various fees are involved.

Cost of Refinancing Formula = Escrow & Title Fees + Points + Taxes + Appraisal Fees + Lending Fees + Insurance Fees + Credit Fees etc.

Cost of Refinancing Example

Suppose, Mr. Bill has taken a mortgage loan and is thinking of refinancing it. We have the below information:

Points calculation:

In the above example, the total cost of refinancing = Points + Closing cost

=$(2,295.72+1200) = $3,495.72.

Components of Cost of Refinancing

The cost of refinancing can vary depending on the loan’s interest rate, the borrower’s credit score, relationship with the lender, and the amount of loan. There are various components of the cost of refinancing:

  • Closing Cost – It is usually some percent of the outstanding amount of mortgage.Title Fees and Escrow Fees – Includes both owner and lender policy for the clause of title insurance and the escrow fee. They also include courier fees, miscellaneous drawing, a recording fee, the office’s fee, mortgage document notarization fees, and the notary’s fee.Appraisal Fees – Appraiser charges these fees for the critical property inspection be it an investment propertyAn Investment PropertyInvestment property refers to the real estate acquired to earn returns on the investment through rental income, royalties, dividends or future appreciation, usually in the name of an individual investor, a group of investors or an investment company for a short-term or a long-term investment.read more or owner-occupied.Lending Fees – The lender charges these fees to process a mortgage. It is also referred to as garbage fees. These fees include underwriting, document preparation, processing, funding fees, administrative fees, wire, flood certification charges, and tax service fees.Points – Point is a combination of discount fees and origination fees. Discount fees are prepaid interest paid by the homeowner and are beneficial for reducing interest rates. Origination fees also reduce the interest rate, but they are mainly used to compensate an originator during the complete transaction. One point usually equals 1% of the total amount of mortgage.Taxes – Property taxes as agreed upon on a yearly or half-yearly basis. Other outstanding property taxes must be paid and cleared off at the time of the first mortgage closing.Credit Fees – It is the fees to review the borrower’s credit report to assess the overall credibility in the particular timeframe.Insurance Fees – The borrower’s home insurance policy should be up-to-date at the time of the deal. It usually should not be less than four months. The standard coverage required by the lender is equivalent to replacement costReplacement CostReplacement Cost is the capital amount required to replace the current asset with a similar one at the present market rate. Usually, assets replacement occurs when their repair & maintenance charges surge beyond a reasonable level. read more coverage.

Advantages of Cost of Refinancing

  • Reduction in the interest rate of the mortgage. With an increased credit score, people can procure loans at lower rates. It impacts monthly payments as well.Many people refinance to obtain money. It can be used for purchasing a car, reducing credit card debt, etc. This can be done by taking equity out of the home.

Disadvantages & Limitations of Cost of Refinancing

  • For borrowers with a perfect credit history, refinancing can be a good way to convert a loan to obtain a lower interest rate. Refinancing can be risky for borrowers with bad credit history, or with too much debt.There could be penalties incurred in the cost of refinancing which could be thousands of dollars.Refinancing costs may include paying an attorney and bank fees which can ultimately not be a worthy affair.

Important Points

  • Borrowers must maintain their first and original mortgage for at least 12 months before refinancing, as most banks and lenders mainly check for the criteria to be fulfilled before proceeding. Also, the borrower must check the lender to know all possible restrictions.Borrowers looking for refinancing may get numerous offers by different lenders but sometimes the may get the best interest rate staying with the original lender.Interest rate environments are cyclical and impact new credit and credit refinancing. National monetary policyMonetary PolicyMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more, economic cycle, and market competition can fluctuate interest rates for consumers and businesses.

Conclusion

We can conclude that refinancing cost includes any fees and closing costs. It is always important to shop around for low or free refinancing. It’s worth considering saving thousands of dollars against wrong refinancing while getting a new line of creditLine Of CreditA line of credit is an agreement between a customer and a bank, allowing the customer a ceiling limit of borrowing. The borrower can access any amount within the credit limit and pays interest; this provides flexibility to run a business.read more.

This has been a guide to the cost of refinancing. Here we discuss how to calculate refinancing cost and its formula and example, types, advantages, and disadvantages. You can learn more about accounting from the following articles –

  • Financing Costs DefinitionActual Cash Value vs Replacement CostFormula of Cost of DebtWhat is Refinancing Risk?