Borrowers are always concerned about what it costs to get a loan, as they should be. In the case of a purchase, they have to get a loan because they need the money to finance the property. The costs of the loan are just part of the purchase price of the home. They still ought to be careful shoppers, but they don’t have a choice as to whether to get a loan or not.
In the case of a refinance transaction, it's different. In this case, it's not mandatory that a borrower refinance. He should do it only when the sum of all the benefits is greater than the cost of the transaction. Most borrowers have a tough time calculating the benefits, and it seems as if they don't ask much about that. What they certainly can ask is, "What are the costs?"
Now, what they are thinking about are the points, processing fees, lender underwriting fees, title insurance fee, settlement agent fees, and the like — what I will call "hard costs." But almost no one EVER thinks about "opportunity cost." What's that? Let's discuss further.
A prospect was in my office today wondering about a refinance. That's a good thing, because he is paying 6.25 percent now and we could get a 4.75 percent loan. But he wasn't asking about that. He asked about the costs.
I asked him why he did not refinance a year ago when rates were about the same as today. Quite sheepishly he admitted he had procrastinated. That's okay. We all do that sometimes. At the time, it always seems as if you can procrastinate for free, but in case it wasn't free at all!
The cost that never occurred to him was the "opportunity cost." His failure to act and refinance a year ago resulted in his paying an extra 1.5% in interest for one whole year, a total of over $2,000. That is just as much of a dollar cost as those "hard" costs, but the opportunity cost just isn't as visible.
Even if we assume that he gets a loan that is 1/8th of a percent cheaper than he would have a year ago, that saves him $20 per month. It will take him over 8 years just to re-coup that $2,000 in extra interest he paid. That's what his procrastination cost him.
I think that an important part of my job is to help get my clients act when it is in their best interest, to jar them off of dead center. I do that best by helping them better understand the benefits they are passing up because of their procrastination. This was something I was not able to do this morning with this client, and sadly, he left without acting. Maybe tomorrow he will be more motivated.
So, I hope you now have a better understanding of opportunity cost. If you have been procrastinating in moving ahead on your refinance, I hope you will consider this lesson and move ahead more boldly.
Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower
articles, Randy is a mortgage broker who has financed over $1 billion
in properties. He writes about home buying and real estate finance
topics for CreditBloggers.com.
Randy Johnson Randy is a Credit.com contributor and seasoned mortgage expert. He writes about home buying, mortgage laws and real estate finance issues. He has financed over $1 billion in properties, is the author of How to Save Thousands of Dollars on your Home Mortgage and he is a feature columnist for Savvy Borrower.
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