I think the most frequently asked question I am asked by borrowers is, “What are the closing costs?” In this blog I would like to discuss the charges, fees, points, etc., that are common with a simple VA IRRRL (Interest Rate Reduction Refinance Loan), more commonly referred to as a VA streamline refinance.
We first need to establish the payoff amount. This is the amount of money the borrower’s current lender is going to ask for to pay the loan off in its entirety. Typically it is the unpaid principle balance of the existing loan, plus daily interest up until the funding date of the new loan (anywhere from 15 to 45 days of interest). Sometimes the payoff will also include any shortage in the existing escrow account, as well. Once we determine a payoff figure we add the applicable closing costs to it to arrive at the amount of the new loan.
The way I look at it there are usually five costs associated with a VA streamline refinance.
1. The first closing cost is title fees. They include title services and lender’s title insurance, government recording charges, and transfer taxes. They vary from state to state. On a $200,000 loan they can be as low as $900 in Arkansas or as high as $3,000 in Florida. I’d say the average is around $2,000.
2. The second closing cost is a new escrow account. Your escrow account is used to pay your property taxes and homeowners’ insurance premiums when they come due. Every month you pay 1/12 of your yearly total premium for property taxes and homeowners’ insurance into your escrow account with your lender. When the bill comes your lender should have the funds available in that account to pay it. The amount collected in the refinance for your new escrow account varies depending on what time of year it is and when those bills are due. Sometimes it is possible to transfer the existing escrow account from the old lender to the new lender. This is advantageous because it means the new loan amount will be lower and the monthly savings will be higher. Not all lenders will transfer escrow accounts, however. If it’s not possible then a new escrow account will need to be created (funded) and the old escrow account funds will be refunded to the borrower after settlement, by the lender that was paid off.
3. The third closing cost is daily interest. This is the same as the daily interest added to the unpaid principle balance to arrive at the payoff figure, as previously mentioned. For example, if the loan is closing and funding on the 20th of the month, 10 days’ worth of daily interest will need to be added into the loan to cover the full 30 days of the month. This figure is usually only a few hundred dollars.
4. The fourth closing cost is the VA funding fee. This fee is 0.5% ($1,000 on a $200,000 loan). This fee is collected in the loan by the new lender and sent to the VA. If the veteran borrower on the loan has a VA disability he may be exempt from the VA funding fee so the fee would be zero.
5. The fifth closing cost is discount points. This is the amount of money the interest rate chosen by the borrower will cost. In many cases the lower the interest rate, the higher the cost. The borrower may choose an interest rate that is either costing points, paying back points, or not costing or paying back anything (par). For example, 3.25% may be costing 1.00 pt or $2,000, while 3.75% may not be costing anything, and 4.00% might be paying back 0.5 pt or $1,000 towards closing costs. It all depends on which interest rate produces the best cost versus savings, which your loan officer can discuss with you.
I like to provide three or four examples of different interest rates so my borrowers can compare and see which is the most cost effective interest rate to choose for their refinance.