The Facts You Need to Know about Refinance Costs

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By Melinda (Milli) Haine.

Loan Underwriter

Refinancing existing debt by using the equity in your home to obtain a secured loan is a good way to gain control of your financial situation. Secured loans make it possible for you to consolidate multiple loan instruments into a single, more affordable loan with manageable monthly payments. However, using this type of consumer financing should not be taken lightly. There are refinance costs you need to consider as part of your overall financial strategy.

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What are refinance costs? These are all of the different things you pay for in order to borrow money. Think of these costs in terms of the total cost of owning a car. When you buy a car, it is not a one-time investment that you pay upfront and forget about. You also have to consider the interest you will pay on the loan, your insurance payments, maintenance and repairs, and the cost of fuel. In the same way, there are lots of additional fees and charges you pay when borrowing through a secured loan.

All of these fees and charges are combined with interest in what is called the 'total cost of borrowing'. This total cost is important if you are the kind of borrower who wants to get the most value for your money. Moreover, if you are the kind of person more concerned about the total amount of money you are spending than how much you pay every month, you cannot afford to ignore all of these costs.

A Breakdown of Costs

The best way for us to explain refinance costs is to simply offer a basic breakdown. While all secured loans are different, there are some common charges included by most banks and building societies. Consider the following:

  • Origination Fees – The origination fee is a bank charge assessed to cover the expenses related to reviewing your loan application and seeing it through to approval.
  • Valuation Fee – Most lenders will require a valuation of your home prior to approving a secured loan. Valuations can be conducted online, in person, or by using a combination of both strategies. You will have to pay for the valuation one way or the other.
  • Legal Fees – There are certain legal fees associated with secured loans due to the fact that they are second charge instruments. For example, the lender will have to pay an administrative fee for putting the second charge on your property. They pass that administrative fee on to you.
  • Office Charges – Your lender also spends money on your behalf by way of its own office staff. This portion of their cost of doing business is included in the office charges they apply to a loan.
  • Early Repayment Penalty – The lender prefers that the customer take the entire term to repay a secured loan. This enables them to make as much interest as possible. To discourage early repayment, lenders will impose a penalty. In some cases, the early repayment penalty is quite substantial; in other cases, it is not.
  • Other Penalties – There may be other penalties involved with a secured loan you attempt to obtain. For example, penalties exist for missed, late, and returned payments. These all have to be considered in light of your borrowing needs and monthly budget.

In our list of refinance costs, there is one missing. It is the most important of all: interest. We give interest a lot of attention when comparing refinancing loans, and with good reason. Interest is the single biggest cost of borrowing. You should make sure you understand interest and how it works before you decide to borrow.

Annual Percentage Rate

For the purposes of secured loans, interest is expressed as a percentage of the outstanding balance over a 12-month period. It is known as the 'annual percentage rate'. However, do not be deceived by the term 'annual'; there is a lot more to it than that.

The annual percentage rate is the amount of interest you will pay during each 12-month cycle of your loan. Nevertheless, most secured loans calculate interest on a monthly basis rather than annually. We will explain it using an example rate of 6%.

An advertised APR of 6% means the consumer is charged 6% over a 12-month cycle. When you divide that number to account for each individual payment, you get a monthly interest rate of 0.5%. The bank uses this lower rate to calculate how much of your monthly payment is going toward interest as opposed to principal.

Let's say your outstanding balance is £50,000 this month. Your monthly payment of £299.78 includes both interest and principal. Based on a 6% APR, your first payment would break down as follows: £250 would go toward interest while £49.78 would be applied toward principal. In the second month, interest would be calculated on the outstanding balance of £49,950.22. This cycle repeats itself month after month for the life of the loan.

As you can see, refinance costs associated with interest are reduced with every month you make a payment. By the time you get to the end of the loan, your last few payments are going almost entirely to principal. The bulk of the interest is paid during the first two thirds of the loan term.

Looking at it from this angle, it makes sense to accept a loan with a slightly higher interest rate but a much shorter term. How so? A slightly higher rate at a term half as long will save you substantially in terms of the total cost of borrowing, because you will not be using the bank's money as long.

This understanding should make it clear that finding a loan with low or no early repayment penalties is advantageous. Such a loan will allow you to make extra payments when you can afford it, reducing principal that much faster. The sooner you can get the principal paid off, the less interest you pay over the loan term.

Do the Maths

If you are the type of consumer more interested in affordable monthly payments than the total cost of borrowing, comparing secured loans is much easier for you. Nonetheless, if you are interested in spending as little as you can in order to consolidate high interest debts, you have to consider all of the refinance costs that come with secured loans. It means you have to sit down and do the maths.

Working out these sorts of things may seem complicated if you've never done it before. However, it's not too bad with a little practice. One of the best suggestions we can give you is to take the time to learn about the different costs of borrowing and then apply that knowledge to some fictitious scenarios you create. This will allow you to practice running the numbers before you start looking for loans. With just four or five practice scenarios, you should start getting a clear picture of refinance costs and how these affect borrowing.

Alternatively, why not take advantage of our expert team’s knowledge and let them do the work for you. There is no charge for our professional advice and any conversations we have are completely confidential, we work for you not the lenders.

Our experts can answer any questions you have about secured finance and have access to a whole of market panel of the top UK lenders from which they can find the best offers that suit your individual circumstances in just a few minutes. With Expert help you will be able to compare the offers side by side, understand the full costs of each offer, chose the most appropriate deal and enlist our help to create and submit an optimised application which will ensure your case is seen in the most favourable light by the lender. 

When you are ready to start looking for secured loans, Secured Loan Expert are here to help. We hope you will take advantage of the valuable service we provide. Secured loans are great financial tools – refinance costs notwithstanding.

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