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Closing Costs Could Kill Your Refinance Savings


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TERMINOLOGY

Refinance closing costs add thousands of dollars to a home loan. If they are rolled in, that amount can easily double over the life of the loan. Is adding thousands to your loan ever a good idea?

When It's Good

If refinancing puts you in a much better financial situation in the long run, it might be worth the cost. This could be the case if, for instance, you have an adjustable-rate mortgage and your interest and payments are increasing substantially. 

Another reason might be that you have a great deal of credit card debt and need a consolidation loan. Home loans traditionally have much better interest rates and spread the debt over a longer period. You should consider this option only if you are truly in danger of bankruptcy.

It may also be a good idea if you are able to secure a much better interest rate than you currently have. This is true only when the change in rate is sufficient to far exceed the closing costs over the life of the loan.

When It's Not

Don't be fooled by advertisements that offer home improvement loans that will "give you the house of your dreams." Using these loans to do home improvements that are not absolutely necessary can end up costing you far more than what the improvements are worth. It makes more financial sense to save up and do the improvements a little at a time.

Refinancing to make purchases or take trips is not usually a good idea either. You may want to use the assets you've accumulated to buy something you've always wanted or to do something you truly want to do. However, using your equity in this way means you will be paying at least several thousand dollars extra in closing costs for whatever it is. You may also lose a great deal of your financial stability. Is it really worth the extra cost?

Things to Think About

The closing costs involved with refinancing will cause you to take a giant leap backward. If you get a new loan within five years of the original one, you probably haven't accumulated enough in principal to compensate for the closing costs. These costs will effectively wipe out years of payments. 

There is also mortgage insurance to consider. If your equity drops below 20 percent, you will almost certainly have to carry mortgage insurance. This insurance is money you pay to protect the finance company in case you default. It doesn't help you at all.

If you do decide to refinance shop for the best loan, negotiate your closing costs and try to pay as much of them out of pocket as possible. Your equity is financial strength. It helps determine your credit rating and therefore makes anything you buy on credit cheaper. It is often the greatest asset in your net worth, and it is a savings account that is one of the keys to a bright future. Refinance closing costs will only erode the asset you have worked so hard to build.