The Break-Even Formula
Refinancing costs money. You need to save enough each month to recoup those costs before selling or refinancing again.
Break-even months = Total closing costs / Monthly savings
Example:
- Current rate: 7.0%, loan balance: $300,000, payment: $1,996
- New rate: 6.0%, same balance, new payment: $1,799
- Monthly savings: $197
- Closing costs: $6,000
- Break-even: 30.5 months (2.5 years)
If you’ll keep the loan 3+ years, this refinance saves money. Under 2.5 years, you lose money.
The Rate Differential Threshold
A common rule of thumb: refinance when rates drop 0.75-1% below your current rate. But this ignores your specific loan balance, closing costs, and timeline.
Better approach: run the break-even calculation for your exact situation. A 0.5% rate drop on a $500,000 loan saves more monthly than a 1% drop on a $200,000 loan.
| Current Balance | Rate Drop | Monthly Savings | Typical Break-Even |
|---|---|---|---|
| $200,000 | 0.5% | $60 | 100 months |
| $200,000 | 1.0% | $118 | 51 months |
| $400,000 | 0.5% | $120 | 50 months |
| $400,000 | 1.0% | $237 | 25 months |
| $500,000 | 0.5% | $150 | 40 months |
Higher loan balances benefit more from smaller rate reductions.
Rate-and-Term vs. Cash-Out
Rate-and-Term Refinance
Replace your existing mortgage with a new one at a lower rate and/or shorter term. No cash out. This is the straightforward money-saving refinance.
Cash-Out Refinance
Replace your mortgage with a larger one, keeping the difference in cash. Rates are typically 0.125-0.5% higher than rate-and-term. This is equity extraction disguised as a refinance.
Cash-out makes sense only for home improvements that add value or high-interest debt consolidation (with a plan to avoid re-accumulating debt). Using cash-out for consumption spending creates long-term debt for short-term benefit.
Streamline Programs
If you have an FHA, VA, or USDA loan, streamline refinance options may be available:
- FHA Streamline: No appraisal, no income verification, reduced documentation
- VA IRRRL: No appraisal, minimal documentation, no out-of-pocket costs (can be rolled in)
- USDA Streamline: Reduced documentation
These programs typically have lower closing costs and faster processing. If you qualify, the break-even timeline shortens significantly.
When NOT to Refinance
You’re Deep Into Your Amortization
If you’re 15+ years into a 30-year mortgage, most of your payment is already going to principal. Refinancing restarts the clock at 30 years, and you’ll pay more interest even at a lower rate.
A 20-year-old mortgage at 4% with $120,000 remaining costs $572/month. Refinancing to a new 30-year at 6% costs $719/month. Lower rate on paper, higher payment and more total interest.
You’re Planning to Sell
If you’ll sell within 2-3 years, closing costs likely won’t be recovered through monthly savings.
Your Credit Has Declined
If your credit score has dropped since your original mortgage, the new rate may not be meaningfully better — or it could be worse.
You’ll Extend the Loan Term
Going from 22 remaining years to 30 new years resets your payoff timeline. Unless the rate savings are substantial, the additional 8 years of interest payments offset the lower rate.
The Refi Decision Framework
- Calculate monthly savings at the new rate
- Get actual closing cost estimates from 2-3 lenders
- Divide: closing costs / monthly savings = break-even months
- Compare break-even to your expected time in the home
- If break-even is under 36 months and you plan to stay 5+ years, refinance
- If break-even exceeds 48 months, probably not worth it
HomeStats tracks the 30-year mortgage rate on the national dashboard. When rates drop significantly below your current rate, run the break-even math for your specific situation.