Divide your closing costs by your monthly savings to find how many months until refinancing pays for itself. If that’s 24 months or less, refinance. Just factor in the extra years of interest if you’re resetting a 30-year clock on a loan you’ve already paid down, because a lower rate doesn’t always mean a lower total cost.
Say a refinance that keeps your payoff date costs $4,000 to close and cuts your monthly payment by $200. You break even in 20 months, and the $200 you save each month after that is yours.
Two years is the bar because nobody knows exactly how long they’ll keep a mortgage. A move or a chance to refinance again at a lower rate can end the loan early, and the closing costs are spent either way. A break-even inside two years leaves room for plans to change.
Count only the change in principal and interest. Your property taxes and homeowners insurance stay the same when you refinance, so leave the escrow part of the payment out of the math.
The lower payment can also hide a longer loan. Five years into a $300,000 mortgage at 7%, refinancing the remaining $282,000 into a new 30-year loan at 6% cuts the payment by about $300 a month. By our math, it also adds five years of payments and about $10,700 in total cost, before closing costs. The same 6% on a 25-year term keeps your payoff date, trims the payment by about $175, and saves roughly $53,000 before closing costs.
Ask each lender for a term that ends when your current loan would, then compare the In 5 Years line on each Loan Estimate, the standard form that lists a mortgage offer’s terms and costs. The first number shows what you’d pay over five years, and the second shows how much principal you’d pay off.
A loan advertised with no closing costs still charges for them. You pay through a higher monthly payment instead, which cuts what you save each month.
Before you apply, work out the break-even month and the payoff date for each offer. An offer that breaks even inside two years and pays off no later than your current loan is the one to take.
To get refinance offers, shop the best mortgage lenders.
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