Say you chose a lender for your mortgage refinance. You still have to decide whether you should go for a lower rate with a higher closing cost or a higher rate but with no or minimal closing cost. You can also buy down the rate by paying points.
Making the perfect decision requires a crystal ball. Will the mortgage rate go down in the future? When and by how much? How long are you going to keep this loan? Note I didn’t ask how long you are going to stay in the house, because you can still stay in the house and refinance the loan again if the rate goes down.
The good thing is we have some calculators to help us make this decision. I will use a hypothetical loan as an example. Say I want a $200,000 loan in Missouri with a 30-year fixed rate, I see these choices from a lender’s website:
|Rate||Total Closing Cost|
First I use the Andrew Kalotay Associates’ Optimum Mortgage Refinancing Calculator. I wrote about this calculator in a previous post. I like this calculator because it takes into consideration the possibility to refinance again if rates go down in the future.
I enter the no closing cost loan as my current mortgage. This is very important. Forget about the real current mortgage if it has a higher rate. I know at a minimum I can refinance to 4.5% with no cost. Therefore the no cost loan is my baseline.
Then I enter 4.375% with $1,269 closing cost as my proposed new mortgage. The calculator tells me “Not Yet!” which means I shouldn’t pay $1,269 to take the rate down from 4.5% to 4.375%. The calculator also says Not Yet for the other two scenarios.
Mortgage Professor Calculator
To double check the calculation, I use Mortgage Professor’s Calculator 3a for refinancing one fixed rate loan to another fixed rate loan. Once again, I enter the no cost loan as my current loan.
Mortgage Professor’s calculator asks more questions. I provide some reasonable answers. For my three alternatives to the no cost loan, it tells me:
over 10 years
|4.375%||$1,269||$431||7 years 6 months|
|4.250%||$2,669||$703||7 years 11 months|
|4.125%||$4,241||$770||8 years 6 months|
Paying a higher closing cost will give me some savings over 10 years, although the amount saved is really small. The breakeven period, i.e. the time I have to keep the loan in order to benefit from the refinance is really long.
For my hypothetical example, both calculators tell me it’s really not worth it to pay the closing cost for a slightly lower rate. When it’s time to evaluate your tradeoff between rate and closing cost, try these two calculators.
This is part of a “How to Refinance” series of posts. Other posts in the series include: