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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
Financing closing costs
Dear Dr. Don,
I would like to refinance my home. What are your thoughts about
rolling the closing costs into the loan amount? Does it make sense
to pay for those costs over the life of the mortgage?
Andrew Amortization
Dear Andrew,
Rolling the closing costs into the loan amount on your refinancing
isn't a bad thing -- as long as that is your intention. Mortgage
lenders that advertise no closing costs really mean no cash paid
by the homeowner at closing, other than money from the proceeds
of the loan.
If you don't plan on staying in the house very long,
then you really need to consider these costs when you decide whether
refinancing makes sense. If you add $3,000 in closing costs to a
loan balance of $100,000 and your monthly payment goes down by $50
a month, you need to stay in the house for about five years to recoup
your closing costs.
As you'd expect, and shown in the example below, the
monthly payment is higher when you finance the closing costs. So
it will take you that much longer to recoup the closing costs. The
other side of the coin is that you didn't have to come up with the
$3,000 at closing. Assuming you have the money to pay closing costs,
the $3,000 can stay invested earning you a return. Include the income
from that investment in the analysis, and the difference in payback
between the two approaches lessens.
| |
Paid at closing
|
Financed
|
Financed plus investment returns
|
| Loan amount |
$100,000
|
$103,000
|
$103,000
|
| Loan term remaining |
28 years
|
28 years
|
28 years
|
| Interest rate |
6.5%
|
6.5%
|
6.5%
|
| Closing costs |
$3,000
|
$3,000
|
$3,000
|
| Monthly payment |
$647.02
|
$666.43
|
$666.43
|
| Monthly savings |
$86.75
|
$67.34
|
$67.34
|
| Investment returns* (per month)
|
|
|
$10
|
| Payback (months) |
35
|
45
|
39
|
| *assumes $3,000 is invested
in a CD paying 4% |
Financing closing costs
Dear Dr. Don,
I got an FHA mortgage in June, and am now receiving two to three
letters a week from various businesses and organizations stating
that I am entitled to refinance for free. I was wondering how much,
if any, truth there is to it, if it's really for free or if there
are hidden costs. If not, should I take the offer?
Thanks!
Carsten Cabin
Dear Carsten,
TANSTAFL, meaning "there ain't no such thing as a free lunch."
I got my information on the streamline refinancing process from
the FHA
Library. Mortgage companies may offer FHA streamline refinances
at "no cost" (actually no out-of-pocket expenses to the
borrower) by charging a higher interest rate on the new loan than
if you paid the closing costs up-front.
Other mortgage companies may offer streamline refinances
that wrap the costs into the new mortgage amount. Unfortunately,
there must be sufficient equity in the property to take this approach.
Your equity position is unlikely to have changed much since June.
If the lender is making up the financing costs by
charging you a higher interest rate, you need to ask if the savings
are enough to justify refinancing at this time. You can compare
the two mortgage payments and make that decision. If the lender
is adding the closing costs to the outstanding loan balance, you
can use a payback approach like the one used in the first letter
to determine whether refinancing makes sense.
-- Posted: Dec. 7, 2001
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