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Should I Refinance My Mortgage?

Refinancing replaces your mortgage with a new one, usually to get a lower rate. A lower rate lowers your payment, but refinancing also costs money upfront and often restarts the clock on your loan. Here's how to tell whether it's worth it.

The quick test: break-even

Closing costs on a refinance usually run 2% to 5% of the loan. The most common rule of thumb divides those costs by your monthly savings:

Break-even (months) = closing costs ÷ monthly savings

If you'll keep the loan longer than that, refinancing comes out ahead. It's a good first check, but it leaves something out.

What the shortcut misses

Your monthly payment pays down principal as well as interest. When you refinance into a new 30-year loan, the payment drops partly because the rate is lower and partly because you're paying the loan back more slowly. That means you build less equity each month.

A fair comparison counts three things at any point in time:

1. The payments you've saved so far
2. The closing costs you paid
3. How much more or less you still owe on the new loan

That's what you'd actually be ahead if you sold the home or paid off the loan at that point. Our refinance calculator uses this full comparison.

An example

Say you owe $300,000 at 7.5% with 27 years left, and you can refinance into a 30-year loan at 6% with $6,000 in closing costs.

You save $364 a month, and the refinance breaks even after about 17 months. Here the shortcut gives almost the same answer. If you keep the loan 10 years, you come out about $35,000 ahead.

See this example in the calculator →

When a small rate drop isn't enough

Now say the new rate is only 7% instead of 6%. The payment drops by $166 a month:

• The shortcut says it breaks even in 36 months ($6,000 ÷ $166).
• Counting the slower payoff, it really takes about 53 months, nearly 4½ years.
• If you keep the new loan all 30 years, you pay about $24,000 more in total than if you'd never refinanced, because the loan now runs 3 years longer.

A half-point or smaller drop can still make sense, but only if you'll stay well past the real break-even point and don't let the longer term eat the savings.

The best of both: keep your old payment

You can take the lower rate without stretching the loan. In the first example, keep paying the old $2,162 a month on the new 6% loan and it's paid off in 19 years, 10 months instead of 27 years. Total interest drops to about $213,000, compared with $400,553 on the current loan.

The same idea works with a shorter term. A 20-year loan at 6% has a payment of $2,149, about what you pay now, and over the life of the loan it saves about $179,000 compared with staying put.

Rolling closing costs into the loan

Many lenders let you add closing costs to the new loan, so you pay nothing upfront. That's convenient, but you'll pay interest on those costs. In the first example, rolling in the $6,000 raises the payment by about $36 a month and pushes the break-even to about 18 months.

A refinance checklist

1. Get at least three quotes on the same day, and compare the APR and closing costs, not just the rate.
2. Decide how long you'll stay. If you might move before the break-even point, refinancing probably isn't worth it.
3. Watch the term. Choose a shorter term, or keep paying your old amount, to avoid paying more over time.
4. Ask about PMI. If your home has gained value, a new appraisal may let you drop PMI.
5. Plan for escrow. You may need to fund a new escrow account for taxes and insurance at closing. You usually get the old one refunded a few weeks later.

This article is general information, not financial, investment, or tax advice. Examples are rounded and assume a fixed-rate loan; your lender's numbers may differ slightly.