When you refinance your mortgage, you have two choices:
- Pay closing costs, which means you will get access to the lowest rate offered by your lender
- Avoid paying closing costs by getting the lender to give you a credit to cover your closing costs. In exchange for this credit, you will close with a higher interest rate.
With any choice, there are tradeoffs. So, how do you know which scenario to choose? The decision ultimately comes down to how long you think you will keep your mortgage for. If you think you are going to be in the mortgage for a long enough time to recoup the closing costs with the lower monthly payment, then paying the closing costs is a better option.
If you are unsure or you don’t think you will be in the mortgage long enough, then it is better to avoid upfront costs and take the higher interest rate. For historical perspective, the average life of a mortgage is approximately 6 years, so most often the math suggests it is best to avoid paying costs when refinancing.
Here is an example to illustrate the choice using a basic scenario: