Should You Refinance Your Mortgage? A Break-Even Guide
The Refinance Itch
When mortgage rates drop, headlines scream "Refinance Now!" While a lower rate is tempting, refinancing is not free. It involves taking out a brand new loan to pay off your old one, which means Closing Costs.
To know if refinancing is smart, you must calculate your Break-Even Point: the time it takes for your monthly savings to outweigh the upfront costs.
How to Calculate Your Break-Even Point
The formula is simple:
Total Closing Costs / Monthly Savings = Months to Break Even
Scenario A: The Clear Winner
- Closing Costs: $4,000
- Monthly Savings: $200
- Break-Even: $4,000 / $200 = 20 Months.
If you plan to stay in the home for more than 2 years (24 months), this is a good deal.
Scenario B: The Trap
- Closing Costs: $6,000
- Monthly Savings: $50
- Break-Even: $6,000 / $50 = 120 Months (10 Years).
Unless this is your "forever home" and you are absolutely certain you won't move, 10 years is too long to wait to see a return.
The "Resetting the Clock" Danger
One hidden cost of refinancing is resetting your amortization schedule.
If you have been paying a 30-year mortgage for 7 years, you have 23 years left. If you refinance into a new 30-year loan to get a lower payment, you are now paying for 37 years total.
Even with a lower interest rate, paying interest for 7 extra years might mean you pay more total interest over the life of the home.
The Solution: Refinance into a shorter term (e.g., 20 or 15 years) or keep making your old payment amount on the new loan to pay it off faster.
When to Refinance
1. Rate Drop
The classic reason. A rule of thumb is a 1% drop is worth it, but with large loan balances, even 0.5% can make sense.
2. Removing PMI
If your home value has skyrocketed, refinancing might allow you to remove Private Mortgage Insurance if you now have 20% equity, even if rates are similar.
3. Switching Loan Types
Moving from an Adjustable Rate Mortgage (ARM) to a Fixed Rate Mortgage offers stability, which is valuable even if the rate is slightly higher.
4. Cash-Out
Tapping into home equity for renovations or debt consolidation. Be careful here—you are turning unsecured debt (credit cards) into secured debt (your house).
Summary
Refinancing is a math problem, not a guessing game. Ignore the advertised "low monthly payment" and look at the total cost.
- Check your Closing Costs.
- Calculate your Monthly Savings.
- Divide to find your Break-Even.
Use our Refinance Calculator to do this math instantly.