How long will it take to recoup your closing costs.

by Tom Tousignant

in Blog, Mortgages, Refinancing

I read an article in the paper this week from a home finance ‘expert’.  She closed with the comment, “be sure your refinancing costs can be covered in about six months”.  Great, meaningless, advice. 

Where does the ‘six months’ rule of thumb come from? (Hint: thin air.)  If you are going to move in six months, that is great advice.  If, however, you plan on staying in your home for more than a year or so, what difference does the time to recoup closing costs make?  If you spend less money on interest over time, does it really matter if it takes you six months, or six years to recoup your refinancing costs?

The real number you need to know

What will be your total cost of financing over the period of time you expect to have your mortgage?  A good loan agent should be able to calculate this for you.  It’s a pretty simple calculation, but, unfortunately the vast majority of loan agents are never taught how to do this.  Their training is ‘sales based’ training.  That is, they are trained to prospect, present, close, answer objections, and close again.  That is why so many loan agents came from other industries, and so many more are now leaving the mortgage business to go back to other sales jobs. 

The Total Cost of financing your house is the sum of the closing costs plus the interest you will pay on the mortgage.  By knowing the Total Cost, you can make an informed loan decision.  As an example, consider the case of Fred and Nicole.  They are going to live in their house for at least ten more years.  If they can refinance their current two year old mortgage from a current rate of 6.875% to 5.875%, they will save $274 per month.  However, with the lender fees, appraisal, and legal fees, they need to spend almost $6,000 to do so.  Our newspaper reporter mentioned above would simply divide the $6,000 by 274 and say, “That’s 22 months to recoup your costs, so that’s too long a time period. Don’t refinance and continue paying the bank an extra $274 each month”. 

However, using some good mortgage software, or by looking at the amortization schedule, we showed Fred & Nicole that over the next 10 years, a refinance would have them spending $32,850 less on interest.  Add back the $6,000 in closing costs, and refinancing now would save Fred and Nicole $26,850 in 10 years.

What to do with the savings

Using the priorities I spell out at, the real benefit may not be the $274 per month or $26,850 in 10 years. More important that the Total Cost, may be “What will you do with the savings?”  For Fred and Nicole, they had an adequate emergency fund (Step One), carried no credit card or “bad” debt (Step Two), had adequate protection for their house (Step Three), so they were in a position to choose what the best way to deploy the monthly savings was. (Step Four).  Fred and Nicole decided, with advice from their Financial Planner, that the best use of that money for them was to continue making the same mortgage payment as before, but now more of their payment would go towards principal and less towards interest.  In 10 years, they would have $41,500 more equity in their house by refinancing with a plan.

What this means for you:

  1. Forget outdated rules of thumb, like the one that prompted this article.  If Fred & Nicole needed to recoup their closing costs in an artificially low time frame, they never would have refinanced, and would have a much larger mortgage balance at the end of their 10 year time frame.
  2. Make sure your loan agent can show you the real numbers.  Remember, his training may only be in how to close the sale, so if he/she can’t answer your questions, find a mortgage professional who can. is a great place to find a local mortgage planner.
  3. Know the Total Cost of home ownership.  Your refinance decision is not about interest rates or closing costs.  It’s about the amount of money you will spend to finance your house.  Closing costs are irrelevant if you save more money over time with a lower rate.  Conversely, the lowest rate with very high closing costs will be very expensive if you need to sell your house in 1-2 years.
  4. (Commercial)  If you can’t find someone who can show you the true “Total Cost’ of home ownership, give me a call – that’s what I do.
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