That’s good news for homeowners who haven’t already refinanced over the past year. Refinancing to lower your interest rate can potentially save you thousands of dollars over the life of your loan.
But it’s important not to hinge your decision on whether or not to refinance solely on the refinance rate you’re eligible for. “[A low rate] doesn’t tell you the story, because you can buy whatever rate you want,” says Gordon Miller, president of North Carolina-based Miller Lending Group. Depending on the lender and loan, you could pay higher fees for a lower rate or have fewer fees in exchange for a higher rate.
Fees vary widely from one lender to the next, and your refinancing closing costs can easily be overlooked if you’re only focused on the interest rate or what your new monthly payment will be. And these fees can easily raise the cost of a refinance, even if you’re reducing your interest rate.
So before making a final decision, here are the important things to consider when you’re considering a mortgage refinance.
3 Reasons a Low Rate Doesn’t Matter As Much As You Might Think
You can’t control the broad economic factors that influence mortgage rates, but that doesn’t mean you’re helpless when it comes to getting the best refinance deal possible. By comparing offers from multiple lenders, and understanding what options are available to you, you’ll put yourself in a better position to find the best deal for your situation.
1. Understand What the APR Shows You
A loan’s annual percentage rate (APR) can be a more useful number to compare than its interest rate. “APR covers things like brokerage fees, origination fees, [and] mortgage insurance, so it’s a better measure to compare across loans,” says Mark McArdle, assistant director, mortgage markets at the CFPB. Typically, a lower APR is better than a higher APR.
But the APR on your Loan Estimate isn’t always the only number to consider. When two loans have the same interest rate, the APR shows you which one has higher fees. But when the interest rate is different, the APR may not tell the whole story.
The APR includes closing fees and is calculated over the full loan repayment period, but if you sell or refinance early, then the closing fees could make a loan with a lower APR more expensive in the short term. Let’s say you’re refinancing a $300,000 loan for 30 -years, here’s how three different loan options would play out:
|Interest Rate||Fees||APR||Total Cost Over 3 Years||Total Cost Over 5 Years||Total Cost Over 10 Years||Total Cost Over 30 Years|
When you’re only comparing loans with the same interest rate, such as Loan A and Loan B, then the option with the lowest APR (Loan A) will be cheaper. But if the fees and interest rate don’t match, then hefty upfront fees can make a mortgage with a lower APR and interest rate actually more expensive in the short term. In this example, you’d end up paying more for Loan C during the first 5 years than you would with Loan A or Loan D, even though both have a higher APR.
It’s difficult to predict the future, but knowing if you plan to move or refinance in five years or less can at least give you an idea of which of these example loans to choose from. If you plan to keep the same mortgage loan forever, then Loan C wins out. If you plan to move in five years or less, then Loan D has more savings.
2. Pay Attention to the Closing Costs and Shop Around
For most people, your home loan is your biggest financial commitment, so it’s essential to talk with more than one lender. “Most people don’t even shop for loans,” says Andrew Pizor, staff attorney with the National Consumer Law Center in Washington, D.C. Pizor says shopping around for the best lender should be a top priority for people.
When you’re looking for a mortgage lender to work with, contact at least two or three lenders to discuss your options. Different lenders charge varying rates and fees, and also offer different types of loans or repayment terms.
Keep in mind that whatever you are quoted on the phone or internet isn’t set in stone. To accurately be able to compare offers you’ll need to submit applications with each lender and within three business days of receiving your application you should receive a Loan Estimate from the lender. “If you look on page three of the Loan Estimate, there’s a little box for comparison, “ says Jessica Russell, mortgage data assets program manager at the Consumer Financial Protection Bureau (CFPB). On page two you’ll find a list of services you can shop for and which you cannot, Russell says.
Later on, even once you’ve settled on a lender to proceed with, it’s also a good idea to compare your initial Loan Estimate to the Closing Disclosure, which is a final version of the Loan Estimate you are supposed to receive at least three business days before closing. Check to confirm that the key details and numbers haven’t changed significantly. The CFPB has rules in place that limit which fees can change between your Loan Estimate and Closing Disclosure and which fees cannot be adjusted. “If anything has changed in a way that you don’t like, you do have the right to put the brakes on things,” Pizor says.
Overall, loans with the best combination of lower interest rates and fewer fees are almost always going to end up being the best deal, regardless of your circumstances.
3. Know the Difference Between “No-Cost” and “No-Out-of-Pocket-Cost” Loans
When you’re refinancing it’s worth considering if a no-closing-cost refinance is right for you, but beware that the term can be misleading. These types of loans work in two ways: you either will have your fees added onto your loan amount or you can have the lender pay the fees in exchange for a higher interest rate.
It’s important to know the difference and ask which options are available to you, because loans with no upfront fees can also be more affordable in certain situations, even with the higher interest rate.
Lenders have an incentive to keep costs low when you’re not paying for the fees. “There’s no reason for them to pad things because it comes out of their pocket,” Pizor says. Even with a “no-cost” loan’s higher interest rate,” … the lenders are going to be less likely to jack up the interest rate too far because they know you’ll go somewhere else.”
An Urban Institute study found that “no-cost” FHA loans were $1,200 cheaper than other alternatives, which represents an approximately 35% reduction in closing costs. When you’re not paying lender fees, the interest rate and the APR are the same. Having to compare only one number across lenders can also make it easier to shop around.
Given how difficult it is to predict how long you may keep your loan and how confusing it can be to compare loan offers, a true no-fee refinance can be a good choice because of the flexibility it can give you. Loan D, from the table above, is a no-fee refinance and in this example, Loan D is less expensive for almost the first 20 years, even though Loan C’s interest rate is significantly lower.
So in some cases, a no-cost loan can be a way to save on interest in the near-term. However, if you never sell your home or refinance your mortgage, then a no-cost loan’s higher interest rate can end up being more expensive in the long run.
Before you commit to a “no-cost” refinance, always ask what fees are covered. “A no-closing-cost loan covers all expenses related to the obtaining of your home loan, not the house itself and not recurring annual charges like your property taxes or homeowners insurance,” Miller says.
A lender may cover some or all of the third-party charges, such as title fees or attorney fees. Third-party charges can make up a huge chunk of the closing costs, and Miller says that the biggest bait and switch is “no-cost” loans that don’t cover third-party fees.
Update: An earlier version of this story incorrectly stated which loans from the table were the cheapest and has been adjusted when each option is the best deal.