There is an old rule of thumb that says refinance when you can drop your rate by a full percentage point. Ignore it. It was never accurate and it is less useful now than ever.
The right question is not how much your rate drops. It is how long until the savings pay for the cost.
The break-even calculation
Take your total closing costs. Divide by your monthly savings. That gives you the number of months until refinancing pays for itself.
Consider a hypothetical. Closing costs of $6,000 and monthly savings of $200 gives you a break-even of 30 months. If you plan to stay past that, the refinance works. If you might sell in two years, it does not.
Now consider a second hypothetical. Closing costs of $3,000 and monthly savings of $150 gives you a 20-month break-even, even though the rate reduction was smaller. Lower costs did more work than a bigger rate drop.
This is exactly why the one-percent rule fails. It ignores the cost side entirely.
The part people forget
Refinancing restarts your loan.
If you are eight years into a thirty-year mortgage and refinance into a new thirty-year, your payment drops partly because you just gave yourself thirty-eight total years to pay off a house.
Your monthly number looks better. Your total interest paid over the life of the loan may be worse.
There are ways around this. Refinance into a shorter term, or keep the longer term and pay extra toward principal voluntarily. Both work. Just know what you are doing rather than looking only at the monthly payment.
Rate-and-term versus cash-out
A rate-and-term refinance replaces your loan with better terms and no additional money.
A cash-out refinance takes equity out, increasing your balance.
These are priced differently and qualify differently. Cash-out typically carries higher costs because the risk profile is different. If you are only after better terms, do not let a cash-out get bundled in.
Points and credits
You can generally pay more upfront for better terms, or accept different terms in exchange for a lender credit that covers costs.
Both change your break-even, in opposite directions. Paying points pushes break-even further out but increases long-term savings if you stay. Taking a credit shortens break-even but reduces monthly savings.
Which is right depends entirely on how long you will keep the loan. That is the variable that decides almost every refinance question.
Reasons to refinance that are not about rate
Removing mortgage insurance once you have built enough equity.
Shortening your term to build equity faster.
Moving out of an adjustable rate into something fixed for predictability.
Removing a co-borrower from the loan after a change in circumstances.
Consolidating higher-cost debt into a lower-cost structure, with the caveat that you are converting unsecured debt into debt secured by your house.
When not to
If you are moving soon. If you cannot cover closing costs without draining reserves. If you are far into your term and would restart the clock for a marginal gain. If you plan to buy another property soon and need your credit and DTI untouched.
Run it before you decide
The break-even calculation takes about ten minutes with real numbers. Bring us your current statement and we will tell you honestly whether it makes sense, including when the answer is no.
We would rather tell you to wait than put you in a refinance that does not serve you.
Trinity Lending Company | NMLS #2762052 | Equal Housing Opportunity