Purchase and Refinance
When Is Refinancing My Mortgage Worth It—and How Much Does My Rate Need to Drop?
A refinance is usually worth it when the savings repay the closing costs before you expect to sell or refinance again, and the new term still fits your plans. There is no single rate drop that works for everyone; loan size, costs and time decide it.
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The short answer
There is no single rate drop that makes a refinance worth it. A refinance tends to make sense when what you save each month pays back the cost of refinancing before you expect to sell, move or refinance again, and when the new loan’s term and features fit your goals.
That depends on three things that differ from one homeowner to the next: how much it costs to refinance, how much the new payment saves, and how long you expect to keep the loan.
How break-even works
The break-even point is the time it takes for your monthly savings to add up to the cost of refinancing. To find it, divide the total cost by the monthly savings.
Hypothetical example, with round numbers chosen for illustration only: assume a refinance costs $6,000 in closing costs and lowers your principal and interest payment by $200 a month. $6,000 divided by $200 is 30 months. If you expect to stay in the home and keep the loan well beyond two and a half years, the refinance may pay for itself. If you might sell within two years, it likely would not.
This simple version leaves some things out, such as taxes, the time value of money and how much principal you pay down. It is still a useful first test. Your Loan Estimate shows the actual costs to plug in.
Why “drop 1%” is only a rough rule
You may have heard that a refinance only makes sense if rates fall by a set amount, such as one percentage point. Rules like that are a shortcut, not a standard. The same rate drop can mean very different savings depending on your situation.
- Loan size: a smaller rate drop on a large balance can save more dollars each month than a larger drop on a small balance.
- Costs: lower closing costs shorten the break-even time, so a smaller drop may still work.
- Time: if you plan to stay many years, a smaller drop has longer to pay off. If you may move soon, even a larger drop may not.
Don’t overlook the remaining term
Comparing monthly payments alone can be misleading. If you are seven years into a 30-year loan and refinance into a new 30-year loan, you are adding seven years of payments. Your monthly payment may fall while the total interest you pay over time rises.
Ask to see the total cost over the time you expect to keep the loan, not just the new payment. Some homeowners choose a shorter term to avoid extending their payoff date, or keep making their old payment amount on the new loan. Each choice has a different effect on your budget.
Lender credits, points and “no-cost” options
You can often trade between a lower rate and lower upfront costs. Discount points mean paying more at closing for a lower rate. Lender credits work the other way: the lender covers some closing costs in exchange for a higher rate. With credits, you pay less up front but more over time.
A refinance advertised as having no closing costs usually still has costs. They are covered by a higher rate, added to the loan balance, or both. That can be a sensible choice if you may not keep the loan long, because there is less to earn back. Ask to see the same refinance with costs paid at closing and with costs covered by credits, side by side.
Reasons beyond a lower rate
Not every refinance is about the rate. Some homeowners refinance to move from an adjustable rate to a fixed one, to shorten the term, or to remove mortgage insurance, such as an FHA annual premium that would otherwise last for the life of the loan. A cash-out refinance turns home equity into cash but increases what you owe, so it deserves its own comparison with alternatives such as a home equity line of credit.
Each of these depends on qualifying at the time, including your credit, income and the home’s appraised value. Any tax effects belong with a tax professional.
Running your numbers with Jack Terrell
If you are wondering whether a refinance makes sense for you, Jack Terrell can help you compare your current loan with the options available now, including break-even time and total cost over the years you expect to keep the loan. As a mortgage broker, Jack can compare programs from more than one lender. Sometimes the answer is that your current loan already fits best, and that’s useful to know too.
This article provides general information about real estate financing in California. It is not a loan offer, pre-approval, commitment to lend, or personalized legal, tax, or financial advice. Programs, availability, terms, and eligibility requirements vary by lender, property, and borrower and may change. Review the disclosures and loan documents applicable to your transaction and consult a qualified professional for tax, legal, or estate-planning guidance.
Jack Terrell, Mortgage Broker and Loan Originator | NMLS #103232 | CA DRE #00992181
California Mortgage Advisors, Inc. | NMLS #1825 | CA DRE #01170868
Licensed by the California Department of Real Estate.
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