Low-cost refinance has trade-offs

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Many homeowners are on the hunt for a so-called “low-cost refinance.” But the term may be misleading.

In common use, the term “low-cost refinance” typically means the closing costs on the loan are lower. Closing costs can include such items as title insurance, loan origination fees, recording fees.

But a loan that has low closing costs may in fact be more expensive for the borrower, if the interest rate and total interest expense over the term of the loan are higher than they otherwise would be. Whether through closing costs or interest, the lender will expect to make its target profit — or more — on the loan.

Focus on refinance goals

Rather than seek out a vaguely defined “low-cost refinance,” homeowners should consider their objectives for refinancing and look for a loan that helps them meet those goals. A few examples would be:

  • A refinance loan with a low fixed-interest rate.
  • A refinance loan with an affordable monthly payment.
  • A refinance loan with a lower total interest expense.
  • A refinance loan with low closing costs.

Of course, everyone would like to find a home loan that has low closing costs, a low interest rate, a low monthly payment and a low total interest expense. Most homeowners, however, need to make some trade-offs in those goals.

Points lower rate

For example, some borrowers choose to pay points to “buy down” or reduce the interest rate on their loan. A point is an upfront payment equal to 1 percent of the loan amount. Each point or fraction of a point lowers the rate, according to a chart of rates and points being offered. Paying points generally makes the most sense for homeowners who intend to keep their loan for a long time.

The bottom line is that homeowners should focus on which costs they want to lower because the interest rate, monthly payment, total interest expense and closing costs are all interconnected moving parts in a refinance loan.