When mortgage rates drop, many homeowners start asking whether they should refinance. Sometimes the answer is clearly yes. Often it depends on a few numbers that are easy to work out once you know what to look for. Here is how I help clients decide.
Focus on the break-even point
An old rule of thumb said a refinance only makes sense if you can lower your rate by at least two percentage points. That rule was always arbitrary. What really matters is how long it will take for your monthly savings to pay back the cost of refinancing, and whether you expect to stay in the home longer than that.
Here is a hypothetical example. On a 30-year, $400,000 mortgage at 7.5%, the monthly principal and interest payment is about $2,797. Refinancing to 6.5% lowers the payment to about $2,528, a savings of about $269 a month. If closing costs are $8,000, it would take about 30 months to break even ($8,000 divided by $269). If you plan to stay in the home for more than two and a half years, the refinance may be worth it.
Smaller rate reductions take much longer to pay off. The table below shows monthly savings on a hypothetical $100,000, 30-year mortgage starting at 7.0%, with $2,000 in closing costs. Multiply the savings by the size of your loan in hundreds of thousands to estimate your own.
| Rate reduction | Monthly savings | Months to break even |
|---|---|---|
| 0.50% | $33 | 60 |
| 0.75% | $50 | 40 |
| 1.00% | $66 | 30 |
| 1.25% | $82 | 24 |
| 1.50% | $98 | 21 |
| 2.00% | $128 | 16 |
Figures are hypothetical, include principal and interest only, and are rounded.
How long you expect to stay
Because of that break-even period, how long you plan to live in the home is one of the most important variables. If you may sell or move in the next couple of years, a refinance with meaningful closing costs is unlikely to pay off.
Look at the full cost, not just the rate
Closing costs can include lender origination fees, discount points, appraisal and application fees, title search and title insurance, attorney or settlement fees, and government recording fees and taxes. Ask each lender for a Loan Estimate so you can compare the total cost side by side. Paying points lowers your rate but raises your upfront cost, which lengthens the break-even period.
Also consider the loan term. Refinancing a mortgage you have paid for 10 years into a new 30-year loan lowers your payment partly because you are stretching the balance over more years, which can increase the total interest you pay. A 15- or 20-year term, or continuing to pay your old payment amount, can avoid that.
A note for New York homeowners
New York charges a mortgage recording tax when a new mortgage is recorded, which can make refinancing more expensive than in many other states. Many New York lenders offer a Consolidation, Extension and Modification Agreement (CEMA), which lets you assign your existing mortgage to the new lender so you pay the recording tax only on any new money you borrow, not the full balance. Ask your lender and attorney whether a CEMA is available.
Shop around
Your current lender may be able to refinance more quickly because it already has your information, but that should not be your only consideration. Compare offers from several lenders, run the numbers for your own loan, and ask plenty of questions. If a refinance frees up cash each month, having a plan for that money, whether it is paying down other debt or adding to savings, is what turns a lower payment into real progress. For more on managing debt, see Deconstructing Your Debt-to-Income Ratio.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
