Is a lower interest rate worth the closing costs?

November 26, 2008 11:28 AM

Interest rates are down, so my mortgage broker contacted me to see if I want to refinance. I'm under the impression that every time you refinance, you lose value in the house, so is this a good idea?

I'm only 16 months into a mortgage @6.75%(fixed, 30-year) and am being told I could get one @ 5.625%(also fixed, 30-year), saving $150/month. Closing costs are around $3000. This sounds good over the long run, but is it really?

What's the money angle? Who is making money here, and who isn't?

Bonus question: my wife thought if we were refinancing anyway, why not get another $10K to fix up the bathroom (and only saving $100/month). Is this a worse idea?

posted by MtDewd to work & money (12 answers total)

The 3k closing costs is where they are making $ and also where you are paying/losing value. If you can justify the 3k by comparing how long you plan to stay in the house (amortize the 3k vs. tha savings between 6.75% and 5.625%
The answer to the other question is the same. How long are you planning to stay in the house vs the investment in a new kitchen.
posted by Gungho at 11:48 AM on November 26, 2008

I'm not sure what you mean by "lose value in the house", but a couple of things to keep in mind:

By refinancing to 30 years again, you've now pushed the end date of the mortgage by another 16 months. This may or may not be important to you.

Closing costs seem a little high to me. When I refinanced (keep in mind this was five years ago), my mortgage company did the refinance with no closing costs. They FedExed me the documents, I signed them with a Notary Public and fedexed them back.

I believe that one of the reasons your mortgage bank is doing this is to make sure your mortgage stays with them. So the bank continues to make money off of you (but a little bit less now), rather than you going off and refinancing with another company.

Adding $10K on to your mortgage also means that you automatically have $10K less of equity in your house. If you're planning on staying in the house for a long time, that may be OK. The same could be said of the $3000 closing costs up front vs. $150/month savings. If you're staying long enough that this comes out to your benefit, good for you.
posted by dforemsky at 11:49 AM on November 26, 2008

every time you refinance, you lose value in the house

This is not true. What determines the value of your house is the value of other, similar houses around you. (ie: What would someone pay on the open market for a house like yours.)

What you need to pay attention to is this: What is the value of your house vs. the amount of debt you owe on your house (ie: the mortgage). A simple refinance, where you drop your monthly payment by a certain amount isn't a bad idea if you're going to stay in your house long enough to make up the savings on the closing costs. (Your closing costs are $3000. $3000/$150 = 20. Thus, if you're planning to stay in your house more than another 20 months you'll make back the closing costs and save money in the long run.)

Adding the $10K may or may not be a good idea, depending on what the current value of your house is and what percentage of that value your current mortgage is. Also, $10K is a hell of a bathroom "fix up".
posted by anastasiav at 11:53 AM on November 26, 2008 [1 favorite]

Being only 16 months into your mortgage, most of your monthly payment is still going toward interest, and almost all the principal in your house is from your down payment. Where is the 10K coming from besides your down payment? If your house is actually gaining value to cover the 10K, count yourselves very lucky. Consider how long you plan to live there, local market conditions, and your own job security. Personally I would not pull $$ out at this point, but the refi may still be worthwhile. You should definitely negotiate on the closing costs.
posted by TDIpod at 11:58 AM on November 26, 2008

If you have the $3000 and planned to stay in the house long-term, then refinance.

I'm under the impression that every time you refinance, you lose value in the house, so is this a good idea
You aren't losing value in the house. Think of it this way-
You are taking out a new loan, at a lower rate, to pay off the old, higher rate loan.

Bonus question: my wife thought if we were refinancing anyway, why not get another $10K to fix up the bathroom (and only saving $100/month). Is this a worse idea?

Now HERE is where you start to run into potential trouble.
If you do this you aren't 'losing value in your home', but you are basically treating it like a piggy bank and taking some of the money out.
To get that extra 10k, it means your new loan is now larger than your old loan.
Taking the 10k out now eats away at the down payment and monthly payments you have made thus far, and you will now own a smaller % of your house.

Refinancing money out of your home for renovation and flat screen tv's is the kind of thing that can get you underwater (owing the bank more money than your house is worth) on your mortgage, and how the economy got into this mess in the first place.
posted by gomess at 12:09 PM on November 26, 2008 [1 favorite]

For what it's worth my mortgage broker covers nearly all the costs for any refi, making them worth it for almost any drop in rates more than a quarter point or so. I recommend you try to negotiate lower closing costs. As previous posters have noted there is really no hidden downside to refinancing assuming you refinance the same amount - your mortgage does extend slightly but you can compensate for that if you choose by making extra payments.
posted by true at 12:26 PM on November 26, 2008

When I refinanced (keep in mind this was five years ago), my mortgage company did the refinance with no closing costs. They FedExed me the documents, I signed them with a Notary Public and fedexed them back.

That's how it worked for me, too. No fees, no fuss, really easy to take care of.

This page on refinancing nicely explains the difference between refinancing for a better rate and refinancing to get cash (which is where you are getting the idea that refinancing means losing value):

A rate-term refinance has a loan amount that is just enough to repay the balance of the existing mortgage. The purpose of the loan could be either to reduce your interest rate, adjust your loan term, or both. A cash-out refinance, on the other hand, has a loan amount that exceeds the current mortgage balance. The higher loan amount converts some of you home equity into cash proceeds, which you receive at loan closing.

That's the difference between just refinancing, saving you about $1800/year, and pulling cash out to have a spiffy bathroom. I'm really conservative financially, so the idea of taking equity out of the house to pay for something that isn't an emergency makes my skin crawl. But your wife is right, it is an option, and certainly a cheaper way to pay for the bathroom than putting the money on your credit card.

Do call around, including credit unions, to see if that is really the best interest rate and closing cost you can get. I know my credit union is advertising lower rates than that, though of course there are other factors.
posted by Forktine at 1:28 PM on November 26, 2008

This sounds good over the long run, but is it really?

Yeah, it is really.

What's the money angle? Who is making money here, and who isn't?

Right now you have a loan with a bank at 6.75% interest. Interest rates are low (and feared to go even lower). So let's say another bank comes along and says, "If you let us, we can buy off the remainder of your debt, and then you can owe us instead, only at a lower interest rate." If you've got 16 months of good payment history behind you, it's in the bank's best interests to keep you as their customer since you're low foreclosure risk.

I would suggest two things:

• Don't even think about this as free money. It's not even money. It's just a few points of a percent. Pretend like nothing happened, except for some reason your monthly payments are less. Funny that.
• Look around for other deals. If you haven't signed anything yet, I would suggest a 5.5% ballpark, no closing costs. Interest rates are going down...

posted by Civil_Disobedient at 2:07 PM on November 26, 2008

In the current economy, see if you can find the money in your budget to do any improvements. The current mess was aggravated by people treating their homes as spending accounts. If your broker has a good deal, somebody else may have a better deal. Credit unions often have great deals with low costs. Mortgage brokers are seeing almost no business and should be willing to find you the best deal. Shop around.

Pay the mortgage at the old payment for a year or so to make up for the 16 months you're extending your debt. Being mortgage free is a great goal.
posted by theora55 at 3:21 PM on November 26, 2008

When you're calculating out the savings, don't forget that if you itemize deductions you'll only actually save $150*(1-your marginal tax rate) every month, not the full $150.
posted by ROU_Xenophobe at 3:52 PM on November 26, 2008

Something else worth considering here - you're looking at paying for years. With a lower interest rate you could reduce your but you could also get a lower , depending on your principal.
posted by Kid Charlemagne at 5:52 PM on November 26, 2008

Thanks for the help. We are going to refinance.
Also, a guest yesterday was taking a shower and water came down into the living room, so it looks like the bathroom is as good idea too.
posted by MtDewd at 6:41 AM on November 28, 2008