You want to lower your interest rate on your VA loan, but you wonder if the closing costs make it worth it. Typically, it is a personal decision on whether or not refinancing with the VA IRRRL program is worth it, but there are some common denominators with every loan that can help you determine the right decision for you.
How much did your Payment Decrease?
The first step is to figure out how much money you are going to save each month by lowering your interest rate. If you are strictly refinancing the amount of the outstanding balance of your loan, you stand to save the most amount of money each month. For example, on a $200,000 loan, if your current interest rate is 6% and you refinance into a 5% interest rate on a 30-year term, you would save $125 per month on your mortgage payment. Obviously, those numbers would change if you were including your funding fee or closing costs in the loan amount, but you get the gist of it.
How much are your Closing Costs?
The next step is to determine the amount of your closing costs. These costs should include the funding fee and any fees the lender, title company, and any other third parties charge you to refinance the loan. Remember, that not every lender charges the same fees, so apply with a few different lenders to see how the costs may differ. One lender might offer you a no closing cost loan in exchange for a .25% higher interest rate while another lender might charge a lower rate and have low closing costs – there is no way to predict what every lender will offer without applying. Once you have a total of all of the closing costs from each lender, you can start to make a decision.
Time to Recoup your Closing Costs
The determining factor regarding whether or not the VA IRRRL makes sense is to determine how long it will take you to recoup your closing costs. For example, let’s say your closing costs are $5,000 on your new VA loan and you are saving $125 per month by lowering the rate. You would simply do the following calculation: $5,000/$125 = 40 months. It would take you 40 months or 3 years and 4 months to make your closing costs back and then start realizing the real savings of refinancing your loan. In the grand scheme of things, 40 months out of a 360 month term is not a lot. Over the remaining 320 months, you would save a grand total of $40,000 by refinancing into the lower rate and paying the closing costs. You can use this same calculation on every loan offer you receive in order to tell which loan makes the most sense for you.
Making the Final Decision
Now, just because you stand to save $40,000 over the life of the loan you are about to refinance into, does not mean that is how much you will actually save. You have to look at the big picture, starting with how long you see yourself staying in the home. Is this your “forever” home or you are planning on moving in the next 5 to 10 years? As you can see, moving would make a difference in how much you would save. In the above example, you would still save a significant amount of money in either time frame:
- Move in 5 years – You would still save $125 per month for 20 months, which equals $2,500 in savings after you recoup your closing costs
- Move in 10 years – You would still save $125 per month for 80 months, which equals $10,000 in savings after you recoup your closing costs
Let’s look at an extreme case, though. What if you were to move in 2 years? You would not recoup your closing costs, which means the refinance would cost you more. This is why it pays to look at the big picture to determine the right choice for you. In this case, it might make more sense to take that no closing cost loan and take the slight increase in interest rate just so you can save a little money each month that you plan on staying in the home, even though it is not long term.
Every VA IRRRL closing will provide you with a document you must sign that shows you exactly how long it will take you to recoup your closing costs. While you should have this figure determined before you get to the point of closing, at least you know you will have a disclosure that will spell things out for you so that you can make sure you are making the right decision in refinancing your home.