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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%

 

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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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See Also
Mortgage calculator
Fight illegal mortgage fees!
Closing costs: the final hurdle

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