Should I refinance my mortgage?

Should You Refinance? A Complete Decision Guide

Refinancing your mortgage can save tens of thousands of dollars—or waste thousands in closing costs. Here’s how to know if it’s right for you.

The Basic Refinance Math

Refinancing makes sense when: Monthly savings × Months until you sell > Closing costs

Example:

• Current payment: $2,100
• New payment: $1,900
• Monthly savings: $200
• Closing costs: $6,000
• Break-even: 6,000 ÷ 200 = 30 months (2.5 years)

If you’ll stay more than 2.5 years, refinancing saves money.

Understanding Closing Costs

Typical Closing Costs (2-5% of loan):

On a $300,000 loan:

• Minimum costs: ~$5,000
• Average costs: ~$8,000
• High-cost areas: ~$12,000+

When Refinancing Makes Sense

Rate dropped 0.75-1%+ from your current rate: The old “1% rule” is outdated. With today’s costs, even 0.75% savings can be worthwhile if you’re staying long-term.

You plan to stay 3+ years: Most refinances break even in 2-4 years. Shorter stays mean you won’t recoup closing costs.

You have good credit (700+): Better credit means better rates. If your credit improved since your original mortgage, you may qualify for better terms.

Your home value increased: Higher equity means potentially avoiding PMI or getting better rates.

You need to switch loan types: Converting from ARM to fixed-rate for stability can justify refinancing even without big rate drops.

When to Skip Refinancing

You’re selling soon: If you’ll move within 2-3 years, closing costs probably won’t be recovered.

Rate difference is small: Under 0.5% difference rarely justifies the hassle and cost.

You’ve paid down significantly: If you’re 10+ years into a 30-year mortgage, refinancing restarts the amortization. You’ll pay more interest even with a lower rate.

Your credit has dropped: Lower credit means higher rates, potentially worse than your current loan.

High closing costs in your area: Some markets have significantly higher closing costs, pushing break-even out further.

The Hidden “Restart” Trap

This is crucial: If you refinance into a new 30-year mortgage, you restart the amortization clock.

Example:

• Original mortgage: $350,000 at 6%, 30 years
• After 8 years: Paid down to $300,000
• You’ve paid ~$120,000 in interest already
• New 30-year mortgage at 5.5%: You pay $314,000 more in interest

Even with lower rate, you pay more total because you’re starting over.

Solution: Refinance to a 22-year (matching remaining term) or shorter.

Refinancing Options

Rate-and-Term Refinance:

• Lower your rate and/or change loan term
• Most common type
• No cash out

Cash-Out Refinance:

• Take equity out as cash
• Higher rates than rate-and-term
• Good for: major renovations, debt consolidation, emergencies
• Bad for: vacations, frivolous spending

Streamline Refinance:

• FHA, VA, and USDA loans offer simplified refinancing
• Less documentation, lower costs
• Must have the corresponding original loan type

No-Closing-Cost Refinance:

• Lender covers costs in exchange for higher rate
• Good for: short-term stays
• Bad for: long-term stays (costs more over time)

How to Get the Best Rate

1. Check your credit first Review and dispute errors before applying. Even 20 points can mean 0.25% better rate.

2. Shop multiple lenders Get quotes from at least 3-5 lenders:

• Your current lender
• Local credit unions
• Online lenders (Rocket, Better, etc.)
• Local banks

3. Compare on the same day Rates change daily. Get all quotes within 1-2 days for fair comparison.

4. Look at APR, not just rate APR includes costs and reflects true cost. A lower rate with higher fees might not be better.

5. Negotiate Lenders compete for business. Ask each to beat competitors’ offers.

The Rate Drop Decision Matrix

Higher starting rates make smaller drops more impactful.

Step-by-Step Refinance Process

Week 1-2: Preparation

• Check credit reports
• Gather documents (pay stubs, tax returns, bank statements)
• Calculate your break-even point

Week 2-3: Shopping

• Get quotes from multiple lenders
• Compare rates and closing costs
• Select lender and lock rate

Week 3-6: Processing

• Complete application
• Schedule appraisal
• Submit additional documents as requested
• Review closing disclosure

Week 5-7: Closing

• Final review of terms
• Sign documents
• Old loan paid off
• New payments begin

Calculating True Savings

Monthly Savings: Old Payment - New Payment = Monthly Savings

Total Interest Savings (over remaining life): This is complex—use an amortization calculator. But remember: restarting a 30-year term often increases total interest.

Net Savings: (Monthly Savings × Months Remaining) - Closing Costs = Net Savings

Example:

• Monthly savings: $200
• Remaining months: 300 (25 years)
• Gross savings: $60,000
• Closing costs: $8,000
• Net savings: $52,000

Making Your Decision

Refinance if:

• Rate drop of 0.75%+ (1%+ is even better)
• You’ll stay past break-even (usually 2-4 years)
• You’re refinancing to the same or shorter term
• Your credit is good (700+)
• You’ve done the full math, not just monthly payment

Skip refinancing if:

• Moving within 3 years
• Rate drop is under 0.5%
• You’re far into your current loan
• Closing costs are unusually high
• You’d extend your loan term significantly

Refinancing can save substantial money, but only when the math works. Don’t be swayed by just the monthly payment—look at total cost and break-even time.