Traditional refinancing -- paying loan fees out of pocket -- became less popular during the housing boom as homeowners chose to apply their growing home equity to pay closing costs. In today's market, refinancing by paying costs yourself is back in a big way.
Refinancing a mortgage involves tradeoffs. Mortgages with the lowest rates often have the highest fees, and vice-versa. Paying for your closing costs out of pocket, instead of financing them or eliminating them by choosing a higher mortgage rate, may cost less in the long run.
Paying closing costs out of pocket is the traditional way to pay for a refinance, but is it the right way for you?
Refinancing costs can be substantial
A typical mortgage refinance comes with a standard set of costs. There is an origination fee (generally 1 percent of the loan amount) as well as charges for credit reports, your appraisal, escrow services and title insurance. There may be other costs, including processing, documentation and underwriting fees.
A good rule of thumb to estimate costs is that these charges will total 2 percent to 3 percent of your mortgage amount. So for a $400,000 mortgage, the cost will likely be between $8,000 and $12,000. (Better yet, you can get a very good working estimate of your actual costs by reviewing your existing loan's HUD-1 settlement form.)
That's no small chunk of change! What if you don't just have that cash lying around?
Traditional refinancing -- that is, just writing a check for that $8,000 or $12,000 -- is just one way to absorb the costs of the refinance. Your mortgage lender can offer other ways to pay for this, whether it's adding the amount to the loan balance or giving you a higher interest rate.
Breakeven considerations
Spending cash today means there are breakeven considerations to think about. It takes time for the savings generated by a refinance to offset its closing costs.
HSH.com's "Tri-Refi" refinance calculator will show you what your breakeven point will be, so you can see if a traditional refinance is best for your needs, or whatever method (Traditional, Low-cash-out or No-cost refinance) might work better.
