Closing Costs
There are two sets of costs involved on a refinance. The first set is the actual “closing costs” to process, approve, close and record the loan. These costs are paid to ‘third parties’, such as appraisers and credit bureaus, which performed part of the necessary tasks required for loan approval.
In order to determine how long it takes to recoup the up-front closing costs, you can take your monthly savings and divide into the closing costs. The typical rule of thumb is that a borrower can recover their costs within 8-21 months.
Example: Monthly savings on new loan: $129/month
Total closing costs: $1617
$1617 divided by $129 = 12.5 months to recoup
You can either roll the closing costs back into your loan balance, if the loan to value position is within guidelines, or you can pay them at closing.
Escrow Account
The second set monies required is the expense to set up your “escrow” account, and the expense of any interest due on your new loan from the day of closing to the end of the month.
The new escrow account will be set up to pay the annual taxes and insurance when they come due. Homeowner’s insurance will be due annually, typically on the anniversary date of your original closing. Real Estate taxes are due either annually or bi-annually. Taxes are paid in “arrears”, which means you are paying for the previous 6 or 12 months.
In Kansas: Taxes are due in May and December.
May is for the 2nd half of the previous tax year.
December is for the 1st half of the current year.
In Missouri: Taxes are due in December for the previous year.
The Real Estate Settlement Procedures Act, or RESPA, allows the lender to set up your escrow account so that is enough money to pay what is due, plus 2 months of reserves. The lender wants to begin your new escrow account with a 2-3 month cushion of taxes and insurance. They will also want to pay the renewals when they are due, and for that reason, the amount collected at your closing may be more than 2 months.
If your current lender is escrowing for taxes and insurance, that balance will be refunded to you AFTER your new loan closing. Since the new escrow account will be offset by the refund, you may or may not want to roll those costs back into your new loan. It is a personal preference. You can obtain your current escrow balance either on your monthly payment statement or by contacting the lender.
Pre-Paid Interest
Your first payment on the new loan will be a minimum of 30 days from the closing. Interest on a loan is paid “in arrears” which means you are paying for the previous month of interest. For example, a July 1 payment is for the June interest accrual. The first payment must have a full month of interest in it.
Depending upon the actual closing date of your loan, there may be some “prorated” interest due at closing. If you are not closing on the 1st of the month, there could be 1-30 days of interest collected; depending upon the day of the month you close. . This is also NOT a cost of refinancing, but the interest on the new loan. [Paying this pro-rated interest on a refinance offsets the higher rate of interest you would be accumulated daily on your old loan].
The same number of days would have been paid on the old loan, if you were not refinancing.
Examples:
November 18th closing.
First payment due January 1st with the payment having a full month of December interest in it. The interest on the new loan begins at closing, November 18th, so there will be 13 days of interest due, from November 18-30th.
April 29th closing date.
First payment due June 1st. Two days of prepaid interest collected at closing, for April 29-30th.
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