When Should You Refinance Your Mortgage?
Refinancing can save thousands — or cost you money. Learn the break-even formula, when it makes sense, and when to skip it.
Refinancing makes sense when the savings from a lower rate exceed the costs — typically when you can reduce your rate by at least 0.75% and plan to stay in the home long enough to break even on closing costs. The average refinance costs 2% to 5% of the loan amount ($6,000 to $15,000 on a $300,000 loan), so you need to recoup those costs through monthly savings before moving or selling. Here is how to calculate whether refinancing is right for you.
The Break-Even Formula
The most important number in any refinance decision:
Break-Even (months) = Total Closing Costs / Monthly Payment Savings
If refinancing costs $8,000 and saves you $200 per month: $8,000 / $200 = 40 months (3.3 years) to break even
If you will stay in the home longer than 40 months, refinancing saves you money. If you plan to move sooner, it costs you money.
Rate Reduction and Break-Even Examples
On a $350,000 remaining balance, 27 years left:
| Current Rate | New Rate | Rate Drop | Monthly Savings | Closing Costs (3%) | Break-Even |
|---|---|---|---|---|---|
| 7.50% | 6.75% | 0.75% | $192 | $10,500 | 55 months |
| 7.50% | 6.50% | 1.00% | $259 | $10,500 | 41 months |
| 7.50% | 6.00% | 1.50% | $393 | $10,500 | 27 months |
| 7.00% | 6.50% | 0.50% | $127 | $10,500 | 83 months |
| 7.00% | 6.00% | 1.00% | $260 | $10,500 | 40 months |
A 0.50% rate drop has an 83-month break-even (almost 7 years). A 1.50% drop breaks even in just 27 months. The bigger the rate improvement, the faster the payback.
5 Good Reasons to Refinance
- Rates have dropped significantly since your original loan: If current rates are 0.75%+ below your existing rate and you will stay 5+ years, the math works clearly in your favor.
- Your credit score has improved substantially: If you originally got a 7.25% rate with a 640 credit score and now have a 760, you could qualify for 6.50% or lower — saving hundreds per month.
- You want to switch from ARM to fixed: If your ARM's fixed period is ending and you want rate certainty, refinancing to a fixed rate eliminates future payment shock.
- You want to shorten your term: Refinancing from a 30-year to a 15-year at a lower rate can save six figures in interest, especially if you are 10+ years into the original loan.
- You need to remove FHA MIP: If you bought with an FHA loan and now have 20%+ equity, refinancing to conventional eliminates the lifetime MIP — saving $150-$300/month permanently.
4 Bad Reasons to Refinance
- To access cash for discretionary spending: Cash-out refinancing to fund a vacation, car, or non-essential purchase converts unsecured spending into 30 years of secured debt on your home. This is almost always a bad idea.
- The rate drop is less than 0.50%: Unless your loan is very large ($500K+), small rate reductions rarely justify closing costs.
- You are restarting a 30-year clock: If you are 10 years into a 30-year mortgage and refinance into a new 30-year, you extend your payoff by a decade. Even with a lower rate, you may pay more total interest over the longer term. Refinance to a 20-year instead.
- You plan to move within 3 years: If you cannot stay long enough to break even on closing costs, refinancing loses money.
Rate-and-Term vs Cash-Out Refinance
Rate-and-term refinance: You replace your existing loan with a new one at a better rate or shorter term. No additional borrowing. This is the standard money-saving refinance.
Cash-out refinance: You borrow more than you owe and receive the difference in cash. Example: you owe $280,000 on a home worth $400,000. You refinance for $320,000 and receive $40,000 cash.
Cash-out refinances typically carry rates 0.125% to 0.250% higher than rate-and-term refinances. They make sense for home improvements that increase property value or to consolidate very high-interest debt (20%+ credit cards). They do not make sense for consumption spending.
Costs of Refinancing
Expect to pay 2% to 5% of the loan amount in closing costs:
| Fee | Typical Cost |
|---|---|
| Origination fee | 0.5% - 1.0% of loan |
| Appraisal | $400 - $700 |
| Title search and insurance | $700 - $1,500 |
| Attorney/settlement fees | $500 - $1,000 |
| Recording fees | $100 - $250 |
| Credit report | $30 - $50 |
| Prepaid interest | Varies (up to 30 days) |
| Total on $300K loan | $6,000 - $15,000 |
Some lenders offer no-closing-cost refinances where fees are rolled into a slightly higher rate (typically 0.125% to 0.250% higher). This eliminates upfront costs but increases your monthly payment. It makes sense if you might move or refinance again within 5-7 years.
When NOT to Refinance
- You are close to payoff: If you have 8 years left on your mortgage, refinancing to a new 15 or 30-year term makes little sense. You would pay closing costs just to extend a nearly-paid-off loan.
- You plan to move soon: A 3-year or shorter timeline usually cannot recoup closing costs.
- You are extending the term without a rate improvement: Going from 22 years remaining to a new 30-year just to lower the monthly payment costs far more in total interest.
- Your home has dropped in value: If your LTV is above 80% (or above 97% for some programs), refinancing may not be possible without PMI, which could offset savings.
Practical Takeaway
Run the break-even calculation first: closing costs divided by monthly savings. If you will stay longer than the break-even period and the rate improvement is at least 0.75%, refinancing almost always makes sense. If possible, refinance into a term that matches your remaining payoff timeline (e.g., from 26 years remaining into a 25-year) rather than restarting at 30 years. Use our refinance calculator to compare your current loan with refinance options and see the exact break-even point.
Try it yourself
Run the numbers with our interactive calculator — drag a slider and watch the chart update instantly.
Open calculatorThis article is for educational purposes only and does not constitute financial advice. Consult a licensed financial advisor for decisions specific to your situation.