When does refinancing your mortgage make sense?
A lower rate is only half of the refinancing decision. The other half is what it costs to get it and how long the new loan runs. A refinance that cuts your payment can still cost you more over time if it stretches your loan back out to 30 years. Here's the math, step by step.
Good reasons to refinance
- A lower interest rate that reduces your payment or total interest by more than the cost of refinancing.
- A shorter term, such as moving from a 30-year to a 15- or 20-year loan to be debt-free sooner.
- Leaving an adjustable rate for a fixed one before an ARM resets (see fixed vs ARM).
- Dropping mortgage insurance, for example moving from an FHA loan with lifetime premiums to a conventional loan once you have 20% equity (see PMI).
Cash-out refinancing — borrowing more than you owe and taking the difference in cash — is a different decision, since it increases your debt. This guide focuses on refinancing to save money.
The break-even calculation
Refinancing is a new mortgage, with closing costs that typically run 2% to 5% of the loan amount. The first test is how long it takes for the monthly savings to repay them:
Break-even (months) = total closing costs ÷ monthly payment savings
If you'll stay in the home — and keep the new loan — well beyond the break-even point, the refinance passes the first test. If you might sell or refinance again before then, it probably doesn't.
Worked example
You owe $300,000 with 27 years left at 7.25%, paying $2,112.58 a month in principal and interest. If you do nothing, you'll pay $384,477 in interest over the remaining term. A lender offers 6.25% with $9,000 in closing costs. Here's how the choice of term changes everything:
| Option | Payment | Monthly change | Break-even | Remaining interest | Net savings (after $9,000 costs) |
|---|---|---|---|---|---|
| Keep current loan (7.25%, 27 yrs) | $2,112.58 | — | — | $384,477 | — |
| New 30-year at 6.25% | $1,847.15 | −$265.43 | 34 months | $364,975 | $10,502 |
| New 27-year at 6.25% | $1,919.05 | −$193.54 | 47 months | $321,771 | $53,706 |
| New 25-year at 6.25% | $1,979.01 | −$133.57 | 68 months | $293,702 | $81,775 |
| New 20-year at 6.25% | $2,192.78 | +$80.20 | — | $226,268 | $149,209 |
The 30-year refinance has the biggest payment drop and the fastest break-even, but it adds three years of payments and saves only about $10,500 overall. Matching your remaining 27 years saves more than five times as much. And if you can afford a slightly higher payment, a 20-year refinance saves nearly $150,000 while making you debt-free seven years sooner than your current loan.
The term trap: every refinance into a new 30-year loan restarts the interest-heavy early years of the amortization schedule. If you refinance for a lower payment, consider continuing to pay your old amount — the difference goes to principal and keeps your original payoff date on track.
Is the "1% rule" still useful?
A common rule of thumb says refinancing is worth it when rates drop by at least one percentage point. It's a reasonable starting point, but the break-even math is better: on a large balance with low closing costs, a drop of half a point can pay off quickly; on a small balance, even a full point may not justify $6,000 in fees. Plug your own numbers into the formula above.
Keeping refinancing costs down
- Get Loan Estimates from several lenders, including your current servicer, and compare origination charges and APR (see APR vs interest rate).
- Ask about streamline programs if you have a government-backed loan: FHA Streamline and the VA Interest Rate Reduction Refinance Loan (IRRRL) often require less paperwork and no new appraisal.
- Ask for a title insurance reissue rate, which is often discounted if your existing policy is recent.
- Be careful rolling costs into the loan. It avoids paying cash, but you'll pay interest on those costs for the life of the loan and your break-even takes longer.
Refinance checklist
- Find your current balance, rate and remaining months on your latest statement.
- Get at least two or three Loan Estimates for the new loan.
- Calculate the break-even in months using total closing costs.
- Compare total remaining interest, not just the payment, for each term you're considering.
- Make sure you expect to keep the home and the loan well past the break-even point.
- Check your credit report beforehand; a better score can mean a better rate.
Model your new loan. Enter your current balance as the home price, $0 down, and the new rate and term — the "Principal & interest" line is your new loan payment.
Open the calculator