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Refinance: When Does It Pay?
A lower rate sounds like a win, but a refinance has closing costs and a new term — and both can eat the saving. Here is how to tell whether it really pays.
What refinancing really does
Refinancing means taking out a new loan to pay off the old one. The new loan has a new rate, a new term and new closing costs. The point is usually a lower monthly payment, a lower rate, or a shorter term — but a lower payment does not always mean a better deal.
Take the example on the refinance calculator: a $300,000 balance, 7.5% now, 25 years left, refinanced to 6.0% over 30 years with $5,000 of closing costs. The payment falls from $2,216.97 to $1,798.65 a month, a saving of $418.32 a month. That looks like a clear win. But total interest only falls from $365,092.06 to $347,514.57 — a saving of $17,577.49 — because the new loan runs five years longer.
Break-even months
The first question is how long it takes for the saving to cover the closing costs. Divide the closing costs by the monthly saving: $5,000 / $418.32 = 11.95 months, about a year. If you stay in the home longer than that, the refinance starts to pay. If you sell or refinance again before then, you lose money on it.
That is the test that matters most. A refinance that saves $400 a month but costs $8,000 to set up needs 20 months to pay for itself. If you might move in a year, it is a bad deal no matter how good the rate looks.
The longer-term trap
The second question is the term. Refinancing to a longer term cuts the payment more, but it adds years of interest. Refinance the same $300,000 to 6.0% over 25 years — the same term as the old loan — and the payment is $1,932.90 a month, a saving of $284.07 a month, with a break-even of 17.6 months. The monthly saving is smaller, but total interest falls to $279,871.26, a saving of $85,220.80. Compare the new loan at the same term as the old one, or you are comparing two different things.
When refinancing makes sense
It usually makes sense when the rate drop is at least around one point, the balance is large enough for the saving to matter, the closing costs pay for themselves well before you plan to move, and the new term is no longer than the old one — or you pay the new loan off on the old schedule. It makes less sense on a small balance, with high closing costs, or when you plan to move soon.
Questions to ask your lender
Ask for the loan estimate and check the closing costs line by line. Ask whether the rate is locked and for how long. Ask what the payment is at the same term as your current loan, not just at 30 years. And ask whether paying the closing costs up front beats rolling them into the loan — rolling them in means you pay interest on the fees too.
Frequently asked questions
Is it worth refinancing from 7% to 6%?
On a $300,000 balance it can be: the worked example on this site saves $418.32 a month to a 30-year term, or $284.07 a month to a 25-year term, with $5,000 of closing costs. On a $100,000 balance the saving would be about a third of that, and the closing costs might never pay for themselves.
How many times can you refinance?
There is no legal limit, but each refinance has closing costs, so refinancing often is expensive. Most people refinance when the rate has fallen enough to be worth it, then leave the loan alone.
Does refinancing hurt your credit?
A lender checks your credit when you apply, which can dip your score a little for a short time. Shopping for rates within a short window is usually counted as one check, so it is better to compare lenders close together.
Sources and method. Standard amortization formula: monthly rate r = annual rate / 12, n = years × 12, payment M = P × r × (1+r)n / ((1+r)n − 1). PMI usually ends when the loan balance reaches 80% of the home value (Consumer Financial Protection Bureau guidance). Affordability uses the 28/36 rule of thumb used by many lenders. Rates in examples are examples only, not live market rates. Results are estimates, not financial advice.
Estimate, not financial advice. This calculator uses the standard amortization formula and the numbers you type in. It is not a loan offer and not financial advice. A lender will check your credit, income and debts and quote its own rate and fees before you borrow.