Signs You’re Paying Too Much for a Refinance

Read Time: 4 minutes

When it comes to a mortgage refinance or anything else, nobody likes to pay more than they should. But what should you look for when shopping for the best refinancing options? Can you rely on featured interest rates alone?

Here are some of the factors to watch when exploring refinancing options.

The Origination Fee

An origination fee, according to the Consumer Financial Protection Bureau, is “what the lender charges the borrower for making the mortgage loan. The origination fee may include processing the application, underwriting and funding the loan, and other administrative services.”

In addition, there are two important points to know about origination fees: First, the origination fee, no matter how big or small, does not raise or lower the interest rate. Second, this is a negotiable cost. If you have leverage with the lender you may be able to bargain over fees and charges. 

Interest Rates and Points

It may sound fairly clear when someone says that a refinancing program is available at 6.5%. If another lender offers 6.75% or even 7%, the low bid will certainly be enticing. But one needs to ask, is there more to the story?

Mortgage pricing often consists of a given interest rate – say 6.5% – plus an upfront fee called a “point” but also known as “loan discount fee” or “prepaid interest.” 

A point is equal to 1% of the mortgage amount, so if you borrow $100,000 a single point is equal to $1,000 at closing. It’s possible for the upfront fee to be something other than 1 point, say a half point (.5%), or an eighth of a point (.125%), or 1.5 points (1.25%).

So which is a better deal: A $200,000 refinancing at 6.25% plus 1 point or a loan at 6.5% and no points? 

We first have to ask how much a point is worth. Some lenders will reduce the mortgage rate by .25% for each point paid up front, some will offer a bigger discount and some less. 

Let’s work with some numbers.

  • A $200,000 mortgage at 6.5% and no points has a monthly cost for principal and interest of $1,264.14.
  • The same mortgage at 6.25% has a monthly cost of $1,231.43 – a monthly saving of $32.71.
  • A point is equal to 1% of the mortgage amount, or $2,000 at closing. 
  • Divide $2,000 by $32.71 and we can see that it will take 61.14 months – a little more than five years – to hit the recovery point. In basic terms, if the loan remains outstanding long enough for the borrower to get back their money then paying points can be appealing.

There are other factors to consider as well. For instance, is it likely that the property will be sold or refinanced before the recovery point?

If so, points are hard to justify. Are the borrower’s finances strong enough so that a $2,000 payment is comfortable? That’s a question only borrowers can answer.

APRs Versus Interest Rates

The APR, or annual percentage rate, and the interest rate are two different – and useful – measures. 

The interest rate shows the annual cost to borrow a given amount. If a $1,000 loan has a 7% interest rate it means the lender will receive $70 if the entire $1,000 debt is outstanding for the full year.

With mortgages, the amount outstanding declines with each monthly payment. The result is that while the mortgage rate and payment stay the same each month with a fixed-rate mortgage, the interest cost declines and the principal payment increases.

You can see this by looking at a mortgage amortization schedule. 

With an adjustable-rate mortgage (ARM), the calculations are more complex because the interest rate can move up or down. With each change, the amortization statement will be adjusted. 

The APR is different from the interest rate. It shows the interest cost of the mortgage as well as related financing expenses over the potential loan term.

If you see a loan with a low interest rate but a steep APR, check the Loan Estimate form for high fees and charges. 

Reducing Closing Costs

In the same way that points can be used to reduce mortgage rates, we can also flip the system to reduce closing costs. 

If a $200,000 mortgage is available at 6.5% over 30 years, but a borrower wants to cut upfront closing costs, then one solution might be to accept a higher interest rate in exchange for a lender contribution.

For example, if the borrower offers to pay the lender 6.75%, the monthly cost for principal and interest goes up by $33.06 to $1,297.20. In turn, the lender will pay the first $1,000 in closing costs.

Given rising incomes and the reality that inflation makes cash dollars worth less and less over time, paying a little more interest – while counter-intuitive – can actually be a winning strategy in some cases.

Comparison Shopping

It’s often difficult to compare lender offers because mortgage loans have so many financial nooks and crannies. There are, however, two steps that can help.

First, ask lenders for interest rate quotes with “par” pricing; that is, the mortgage rate with zero points. 

Second, when you receive a mortgage offer, carefully review the three-page Loan Estimate form the lender provides. This is a standard document used by all lenders and allows you to readily compare loan offers.

In particular, look at closing costs and estimated expenses over five years in addition to the interest rate and APR.

Will shopping around really save you money? According to the Consumer Financial Protection Bureau (CFPB), “research suggests that failing to comparison shop for a mortgage costs the average homebuyer approximately $300 per year and many thousands of dollars over the life of the loan.”

The research mentioned by the CFPB is from 2017. With today’s higher prices and bigger mortgages the savings from comparison shopping might be even larger.

Peter G. Miller

Peter G. Miller is a nationally-syndicated columnist, the author of seven books published originally by Harper & Row (including one with a co-author), and has contributed to leading online sites and major print publications. He has appeared on numerous media outlets including the Today Show, Oprah!, CNN, and NPR.

Peter has been an accredited correspondent on Capitol Hill and a member of the White House Correspondents Association. He has served with the District of Columbia National Guard and holds both BA and MS degrees from The American University in Washington, DC. View Peter on LinkedIn.

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