Refinancing means replacing your current loan with a new one, usually to get a lower interest rate, a different term or to release cash. It can save a lot of money, but only if the savings outweigh the costs. The core test is simple: the break-even point.
The break-even formula
This tells you how long it takes for lower payments to repay the fees. If you expect to keep the loan longer than that, the refinance is likely to pay off.
Worked example
You owe $300,000 at 7.25% with 28 years left. Your payment is $2,088.47. A new 30-year loan at 6.25% would cost $1,847.15 a month, a saving of $241.32. If closing costs are $5,000, the break-even point is 5,000 ÷ 241.32 = about 21 months. Stay longer than that and you come out ahead.
The term trap
Notice that the new loan restarts at 30 years, while you only had 28 left. That is a small extension here, and the lower rate still saves about $31,800 over the life of the loan. But stretching the term can raise the total cost even when the payment goes down. If you refinance to a 25-year loan instead, the payment is $1,979.01, still about $109 less than today's, and lifetime cost falls by around $103,000. If your goal is to pay less overall, keep the new term close to the years you have left.
Is a lower rate enough?
You may hear a rule of thumb that the new rate should be at least half a point to a full point below your current one. That can be a useful first filter, but the break-even calculation matters more, since it accounts for your loan size and the actual fees.
Checklist before you refinance
- Get a written estimate of closing costs. They often run from about 2% to 5% of the loan.
- Ask about no-closing-cost offers. These usually come with a higher rate or fees rolled into the loan, so compare the real cost.
- Check for a prepayment penalty on your current loan.
- Think about how long you will stay. If you may move before break-even, refinancing may not pay.
- Compare several lenders on the same day, using the same assumptions.
- Look at the whole picture: PMI, escrow and any cash you take out.
Cash-out refinancing
A cash-out refinance borrows more than you owe and gives you the difference. It can fund repairs or pay off higher-rate debt, but it increases your balance and puts your home at risk if you cannot repay. Use it carefully.
Try your own numbers in the refinance calculator. This article is general information and not financial advice.