When should you refinance your mortgage?

The short answer

Refinancing tends to make sense when the monthly savings pay back your closing costs well before you expect to move or pay off the loan, and the new loan doesn’t cost you more in the long run than you’re comfortable with. The Consumer Financial Protection Bureau suggests looking at how long it takes to break even, and notes that if you’ll move within a few years you may not get there.

1. Compare your rate with today’s

Start with the rate on your current mortgage statement and compare it with today’s refinance rates. Look at the APR too: it includes lender fees and, for FHA and VA loans, mortgage insurance or the funding fee, so it’s the better number for comparing offers.

You may have heard you need a full 1% drop. That’s a rough rule of thumb, not a requirement. On a large loan a smaller drop can pay off quickly; on a small loan even 1% might not cover the costs. Our guide to what a 1% rate drop saves shows the math.

2. Find your break-even month

Divide your total closing costs by your monthly savings. If a refinance costs $5,000 and saves $250 a month, you break even in 20 months. If you’re likely to stay put for years after that, the refinance probably pays off. The break-even calculator does this for you.

3. Watch out for the term reset

If you’re five years into a 30-year mortgage and refinance into a new 30-year loan, you’ve added five years of payments. Your monthly payment can drop while the total interest you pay goes up. Two ways to handle it:

• Pick a shorter term (such as 20 or 15 years) if the payment still works for you.
• Keep the 30-year term but pay a little extra principal each month, so you stay on your original payoff date.

The refinance calculator shows interest left to pay on both loans so you can see the trade-off.

4. Know your closing costs

Freddie Mac says refinance closing costs typically run 3% to 6% of the loan amount. They include lender fees, the appraisal, title insurance and settlement fees, and recording fees or mortgage taxes, which vary a lot by state (see your state’s page). You can pay them in cash, add them to the loan, or take a slightly higher rate in exchange for a lender credit that covers some or all of them.

5. Good reasons to refinance besides a lower rate

• Dropping mortgage insurance. If your home has gained value, refinancing an FHA loan into a conventional loan with at least 20% equity can remove monthly mortgage insurance.
• Getting out of an adjustable rate. An ARM keeps its starting rate only for an initial period, after which the rate and payment can rise. Moving to a fixed rate gives you a principal-and-interest payment that can’t go up.
• Paying the loan off sooner. A shorter term usually carries a lower rate and saves interest, at the cost of a higher payment.
• Taking someone off the loan, for example after a divorce (lender and program rules apply).

6. When it’s better to wait

• You expect to sell before you’d break even.
• Your credit score has dipped recently. Rates are priced by credit score, so a few months of rebuilding can help.
• You have little equity and the new loan would need mortgage insurance your current one doesn’t.
• Your current loan has a prepayment penalty (rare on today’s home loans, but check your note).

7. Already have an FHA or VA loan?

Look at the streamline options first. An FHA Streamline or a VA IRRRL usually needs no appraisal and less paperwork, and each comes with built-in tests to make sure the refinance actually benefits you.

A quick checklist

1. Today’s rate and APR are meaningfully lower than yours.
2. You know your total closing costs.
3. Your break-even month comes well before you expect to move.
4. You’ve compared the total interest on both loans, not just the payment.
5. Your credit and equity are in good shape, or you know how they affect your price.

If the numbers aren’t there yet, you don’t need to keep checking. Set a free rate alert with your current rate and we’ll email you when the market gets to your target.