Personal Finance

Should I Finance My Closing Costs When I Refinance My Mortgage?

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When refinancing your mortgage, you may have the option to finance your closing costs instead of paying them out of pocket. What does it mean to finance your closing costs? It’s when you add the expense associated with your refinance into your new loan amount.

When does rolling this expense into a new loan make sense? If you’re doing a cash-out refinance, your closing costs are generally included in your new loan. And when you don’t have the cash on hand to pay your closing costs, then financing them is likely an easy decision. But there are other times when it may benefit you to dig into the details before making your decision. Let’s start by discussing closing costs and where you can find the ones associated with your refinance.

Closing Costs and Your Loan Estimate

Closing costs are generally the expenses associated with refinancing your mortgage. These expenses might include charges for a home appraisal, credit report, title search, loan application, and loan origination. When you’re refinancing an existing mortgage, it’s common to see closing costs in a range from 2% to 6% of your loan amount. However, this can vary based on the size of your loan and if your lender offers any credits or discounts. For a list of the estimated closing costs associated with your refinance, look at the Loan Estimate form you received from your lender.

The Math Behind Financing Closing Costs

Now that you have an estimate of the closing costs you will pay, it’s time to do a little math. Why is that important? Looking at the numbers can help you understand your options. Let’s look at two calculations related to your monthly payment and opportunity costs.

Monthly Payment

When you make the decision to finance your closing costs, there will typically be an increase in the amount of your monthly mortgage payment. The exact amount of that change will depend on the details of your specific loan. In the loan scenario below, we’re using an estimated closing cost amount of $4,000 which is 2% of the loan amount.

Loan Scenario
Loan Amount: $200,000
Closing Costs: $4,000
Interest Rate: 2.75%
Term of Loan: 30 Years
Closing Costs Paid Financed Closing Costs
Loan Amount: $200,000 $4,000
Amount Due at Closing: $4,000 $0
Potential Interest Savings: $816 $833
Monthly Payment Increase: $17

In this example, there was an increase of $17 in the monthly payment amount when $4,000 in closing costs were financed at a fixed rate of 2.75% on a 30-year mortgage. Your lender can provide a comparison based on your specific loan details, or you can use an amortization calculator to determine the change.

Now that we’ve reviewed an example of the change in the monthly payment when you finance your closing costs, let’s take a look at opportunity costs.

Opportunity Costs

In a discussion about opportunity costs, people typically talk about the benefits that are missed when one option is chosen over another. When you pay your closing costs out of pocket, you are giving up an opportunity to use the money for something else. For example, the money could be used to make home repairs, pay off other debts, or save for a rainy day.

The following example illustrates the opportunity cost when using money to pay closing costs instead of credit card debt. Let’s use the same loan scenario as above along with the following information related to the credit card debt:

Credit Card Debt Scenario
Current Balance: $4,000.00
Estimated Payoff: 60 mos.
Interest Rate: 18.00%
Monthly Payment: $102.00
Credit Card Debt Financed Closing Costs
Monthly Interest Expense: $35.20 $5.22
Interest Paid Over 5 Years: $2,112.00 $313.20
Potential Interest Savings: $1,798.80

In this example, the opportunity to eliminate the credit card debt is lost when that $4,000 is used to pay the refinance closing costs up front. The financed closing costs are only $313.20 over 5 years. The credit card interest would be $2212.00 over that same period. The opportunity to potentially save $1,798.80 over a 5-year period is given up when the closing costs are paid instead of financed. To personalize the concept of opportunity costs to your unique situation, you may want to think about your existing debt, large purchases you want to make in the future, or other goals you may have.

Three More Considerations

When you are considering financing your closing costs, there are three more numbers that might influence your decision. In most cases, your lender will review these numbers with you when it comes time to finalize your loan.

Interest Rate

The interest rate you are offered could be a key factor in your decision to finance your closing costs. When interest rates are low, the increase to your monthly payment will be smaller than at a higher interest rate. Also, the interest expense will be less than when interest rates are higher. This may be significant when you have high-interest debt you’d like to pay off.

If you decide to add your closing costs into your new loan, check with your lender to make sure there won’t be any change to the interest rate you are offered.

Loan-to-Value Ratio

Your loan-to-value (LTV) ratio could play an important role in your decision to finance your closing costs. It represents the equity you have in your home and is calculated by taking your loan amount divided by the appraised value of your home. Your LTV ratio can affect the interest rate you’re offered. Financing your closing costs will increase your loan amount and your LTV ratio to some degree. If your LTV ratio goes above 80%, in many cases, mortgage insurance will be required. Your lender will let you know if a higher LTV affects your interest rate or results in any additional expense.

Debt-to-Income Ratio

Another ratio to watch when deciding whether to finance your closing costs is your debt-to-income (DTI) ratio. It’s the amount of your monthly debt payments divided by your monthly income. Financing your closing costs would likely increase this ratio slightly. Again, you can check with your lender to make sure this won’t affect your interest rate.

Looking at opportunity costs can help you decide if it would benefit you to finance your closing costs and use that money to pay off high-interest debt.

When you refinance your mortgage, consider the opportunity costs of paying your closing costs instead of financing them. To help you make your decision, you can calculate the change in monthly payment and explore the benefits of using the money for something else. Before you move forward, check with your lender to confirm your interest rate won’t be affected by the change in your loan amount, LTV, and DTI ratios.

You can rely on the experienced mortgage professionals at Axos Bank to provide the guidance and support you need when you’re ready to refinance. Call 888-546-2634 to speak with an experienced mortgage specialist today.



Should I Finance My Closing Costs When I Refinance My Mortgage?

This blog post was published by Axos Editorial Team on March 10, 2021 and last updated on March 10, 2021.

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