When Should You Refinance Your Mortgage?
A refinance is worth it when what you save exceeds what you spend — measured over the time you will actually keep the loan.
Why people refinance
- Lower the rate and the monthly payment.
- Shorten the term, for example from 30 to 15 years, to pay less interest overall.
- Remove mortgage insurance once you have 20% equity, or move from FHA to conventional.
- Switch from an adjustable to a fixed rate.
- Take cash out for renovations or to consolidate debt.
Test 1: the break-even point
Refinancing costs money — lender fees, appraisal, title and so on, shown on the new Loan Estimate. Divide those costs by the monthly savings to find how many months it takes to recover them:
Break-even (months) = closing costs ÷ (old payment − new payment)
For a $280,000 balance at 7.25% with 28 years left, refinanced into a 30-year loan at 6.25% with $6,000 of costs, the payment drops by $225.23 and break-even is 2 years 3 months. If you expect to move or refinance again before then, the refinance loses money.
Test 2: the lifetime cost
A new 30-year loan restarts the clock. Even with a lower rate, stretching the remaining balance over more years can mean paying more interest in total. Compare the remaining payments on your current loan with the total payments on the new one, plus costs. In the example above, the new loan saves $28,302 over its life. With a smaller rate cut — to 6.75% instead — the payment still falls by $133.16, but the lifetime result is a cost of $4,842.
Two ways to keep the lower rate without extending your debt: choose a new term close to your remaining term (for example 25 years), or keep paying your old payment amount on the new loan.
The old “1% rule”
You may hear that refinancing only makes sense if rates fall by at least one percentage point. It is a rough shortcut. A smaller drop can pay off on a large balance with low costs; a larger drop may not if you are moving soon. Break-even and lifetime cost answer the question directly.
Cash-out refinancing
A cash-out refinance replaces your loan with a larger one and pays you the difference. It can be a relatively cheap way to borrow, but it resets the whole balance to the new rate — including the part that may have had a lower rate before. If your current rate is low, a home equity loan or HELOC leaves it untouched.
Points and lender credits
When refinancing you can pay discount points to lower the rate further, or accept lender credits (a higher rate) to reduce costs. Points make sense only if you will keep the loan past their own break-even; the points calculator checks this.
Checklist before refinancing
- Get Loan Estimates from several lenders on the same day.
- Calculate break-even and lifetime cost with the refinance calculator.
- Ask about prepayment penalties on your current loan.
- Remember that your old escrow balance is refunded after payoff, while the new loan needs a new escrow deposit.
Sources
- Consumer Financial Protection Bureau, “Loan Estimate explainer”
- Consumer Financial Protection Bureau, “What are (discount) points and lender credits and how do they work?”