Refinancing replaces your existing mortgage with a new one — ideally at a lower rate, shorter term, or to extract equity. But refinancing isn't free, and 'getting a lower rate' doesn't automatically mean it's a good deal. Here's how to analyze whether refinancing makes sense for your situation.
The Break-Even Calculation
Refinancing typically costs 2–5% of the loan amount in closing costs. Before you refi, calculate the break-even point: Closing Costs / Monthly Savings = Break-Even in Months. If you'll move or sell before break-even, refinancing costs you money.
| Loan Amount | Closing Costs (3%) | Monthly Savings | Break-Even |
|---|---|---|---|
| $300,000 | $9,000 | $150 | 60 months (5 years) |
| $300,000 | $9,000 | $300 | 30 months (2.5 years) |
| $400,000 | $12,000 | $400 | 30 months (2.5 years) |
Types of Refinances
- Rate-and-term refi: Change your interest rate and/or loan term. Most common. Goal is lower payment or shorter payoff.
- Cash-out refi: Borrow more than you owe and take the difference as cash. Use it for home improvements, debt payoff, or investment.
- Streamline refi: Simplified process for FHA, VA, and USDA loans — reduced documentation and sometimes no appraisal required.
- No-closing-cost refi: Closing costs rolled into the loan balance or offset with a slightly higher rate.
When to Refinance
- Rate dropped at least 0.75–1.0% below your current rate (rough guideline; break-even analysis is definitive).
- Your credit score has improved significantly since origination.
- You want to switch from ARM to fixed for payment certainty.
- You want to shorten your loan term and can afford the higher payment.
- You want to eliminate PMI by reaching 20% equity with a new appraisal.
- You need liquidity and have significant home equity.
Refinancing into a new 30-year loan resets your amortization schedule. In the early years of a mortgage, most payments go toward interest. If you're 10 years into a loan and refi into a new 30-year loan, you'll pay much more interest over time — even at a lower rate.