As mortgage rates drop to historically low levels, beware of refinancing deals with high costs

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The historic drop in mortgage rates has created mind-boggling deals, with many borrowers freezing 30-year loans well below 3%.


© Bonnie Jo Mount / The Washington Post via Getty Images
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But beware of the borrower: Sometimes a good deal comes with an unpleasant surprise in the form of high closing costs. Don’t get so distracted by the 2-hour rate or the low monthly payment that you lose sight of the big picture, mortgage experts advise.

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“Some lenders are focusing on the 2.5% rate, but the closing costs could be $ 13,000,” says Gordon Miller, owner of the Miller Lending Group in Cary, North Carolina.

Paying a large sum in closing costs is usually not a smart move – these costs absorb the monthly savings that come from a lower rate. However, it is not easy to understand the numbers.

Qualifying and closing a mortgage is a complex transaction with many moving parts. Even savvy consumers can struggle with mortgage deals that include a jumble of jargon and a pile of numbers.

“It’s confusing,” says Kevin Parker, vice president of mortgage field operations at the Navy Federal Credit Union. “It’s overwhelming. “

Record low interest rates trigger wave of refinancing

The average rate on a 30-year fixed-rate mortgage last week was 2.99%, not including origin points, according to credit giant Freddie Mac. Bankrate’s national survey of lenders showed that the 30-year average mortgage rate last week fell to an all-time high of 3.30%, points included.

Nearly 16 million U.S. homeowners could cut their 30-year loan rates by at least 0.75 percentage points by refinancing, according to mortgage data firm Black Knight.

Many homeowners have already refinanced in recent months. The flood of activity created a traffic jam as lenders struggled to keep up. Some mortgage quotes are higher than the national average, a quirk explained by the race of consumers to lock in lower rates.

“Some lenders have so much volume that they’ve raised their rates,” says Alan Rosenbaum, managing director of GuardHill Financial, a New York-based lender. “What they’re really saying is, ‘We don’t want to lend right now until we can catch up.’ “

Take a close look at closing costs

While many homeowners can actually benefit from refinancing, it’s also important to analyze the costs. Closing costs – including appraisal fees, title insurance, credit checks, and other items – can range from 2% to 5% of the loan amount. So, on a loan of $ 300,000, you could pay between $ 6,000 and $ 15,000.

Miller says he saw the closing costs vary even more. He worked with a borrower who was refinancing a loan of $ 300,000 and did not realize that the new loan amount was $ 318,000 – including all these costs built into the loan principal.

It is likely that the borrower will sell the home or refinance it into another mortgage long before lower monthly payments offset these costs.

Keep in mind, Miller says, that the average term for a mortgage is only two or three years, so paying high closing costs doesn’t make sense. Miller believes some industry players are creating “intentional confusion” in the minds of borrowers.

For example, many borrowers focus on the phrase “no direct costs” but ignore the fact that thousands of dollars in closing costs are added to their new loans. In some cases, the fee pushes the borrower’s equity below 20%, adding private mortgage insurance to the tab, Miller says.

Parker says the Navy Federal Credit Union does not charge “underwriting” or “processing” fees which can add hundreds of dollars to closing costs. “In the industry, we sarcastically call these charges unwanted charges,” Parker says.

Navy Federal Credit Union Charges Borrowers for Appraisals, Securities, and Credit Checks “No matter what the provider charges, we just pass it on,” he says.

Calculate the breakeven point

Any refinancing decision must include a break-even calculation. This is when the savings on monthly payments offset the amount of closing costs.

Let’s say you have a loan of $ 250,000 at 3.75%. Your monthly principal and interest is $ 1,157. If you can reduce the rate to 3%, your payment would drop to $ 1,054, a savings of $ 103 per month.

But even if your closing costs are $ 5,000 – at the lower end of the 2-5% range – you won’t be profitable for four years. If you plan to stay in the house for five years and not refinance again during that time, the refi makes sense.

But if you sell next year or refi in two years, you are actually increasing your costs, you are not saving.

What about loans with no closing costs?

If you are nervous about closing costs, there is an alternative: A number of lenders offer loans with no closing costs. The catch is, you’ll pay a higher interest rate.

In one example, Third Federal Savings and Loan of Cleveland does not offer any closing cost loans to homeowners nationwide. This loan had a rate of 3.44 percent in a recent promotion for a 30-year fixed loan, compared to 2.99 percent for a standard loan in which the buyer pays the costs at closing.

To go through the numbers, borrowing $ 250,000 at 2.99% would mean a monthly payment of $ 1,052. Raising the rate to 3.44% would increase the payment to $ 1,114, or $ 62 more per month. However, if the higher rate means avoiding $ 5,000 or more in closing costs, you would make almost seven years of payments before you offset the closing costs.

Miller advocates loans with no closing costs as a means of refinancing essentially for free. You won’t be able to brag about your microscopic interest rate, but you will also feel secure knowing that there is more to refinancing than the interest rate alone.

Rosenbaum isn’t a fan of no-closing cost deals, however, especially if you expect that loan to be your mortgage forever. This is because the higher rate translates to smaller monthly savings which accumulate over the years.

Compare options

Suppose you have a mortgage of $ 250,000 at 4%, with a payment of $ 1,194. Here’s how a $ 250,000 refinance would stack up in several scenarios:

Higher rate, free of chargeAverage price, average costsLow rates, higher costs
Interest rate3,44%2,99%2,5%
Closing costs0 $5 000 $10 000 $
New monthly payment1 114 $1 052 $988 $
Monthly savings80 $142 $206 $
Break evenImmediate35 months42 months

Lending standards have become stricter

Another factor to keep in mind: Banks have reduced the number of applicants who get the best rates, says Rosenbaum of GuardHill Financial. The coronavirus pandemic has led lenders to expand generous relief programs that give borrowers a one-year tolerance. Lenders don’t want to lend to a borrower who stops paying a few months later.

“Most banks have a hard time approving customers,” he says. “Credit standards are getting stricter in all areas. The lending community is just very concerned about where this market is going. Who will be able to pay off their mortgage in the future? Who will ask for abstention? Who is going to lose their job? ? ”

In the midst of the flood of refinances, the lowest rates go to borrowers with great credit scores, solid incomes, and lots of equity in their homes.

“The best rates are for those with the least risky loan profile,” says Elizabeth Rose, Certified Mortgage Planning Specialist at AmCap Home Loans in Plano, Texas. “There are many details that go into a person’s interest rate. Most think it’s just credit score, but other factors like loan-to-value ratio, debt-to-income, among others, are factors as well. Getting an interest rate of around 2.5% or 2.625% will depend on the risk levels. ”

Another consideration: how long will it take for your refinancing to close? Many lenders have long wait times. If you don’t want the process to drag on for months on end, be sure to ask questions and do your research, says Joe Bilko, director of recipes at AmeriSave.

“The rate is the starting point,” Bilko says. “Then you have to go deeper and dig deeper into customer testimonials. “

What you can do

To get the best deal on a mortgage:

  • Compare the prices. Closing costs and rates vary by lender, so get three offers.
  • Understanding the breakeven point. This is when the savings on monthly payments offset the amount of closing costs. This refinance calculator can help you decide.
  • Don’t look for the lowest rate. Yes, a low rate and a pittance are good, but make sure those perks aren’t overwhelmed by closing costs.

Image presented by Bonnie Jo Mount / The Washington Post via Getty Images

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