Should You Refinance? How to Weigh Closing Costs, Break-Even and Your Plans
What You’ll Learn
- Common reasons homeowners consider a rate-and-term refinance
- What closing costs come with a refinance and the trade-offs of paying them upfront, rolling them in or using lender credits
- How to estimate a rough break-even point by dividing total costs by monthly savings
- Why total interest over the time you keep the loan matters as much as the monthly payment
- What to expect when you requalify, compare lenders and close, including the right of rescission
A lower monthly payment sounds like an easy win. But a refinance isn't free. It replaces your current mortgage with a new one, and the new loan comes with its own closing costs. Whether it makes sense often depends less on the rate headline and more on three things: what it costs, what you save and how long you plan to keep the loan.
This guide covers a rate-and-term refinance, where you replace your loan to change the rate, the term or the loan type. If you're thinking about pulling equity out instead, see how a cash-out refinance compares with a HELOC.
Common Reasons Homeowners Refinance
People refinance for different reasons. Some of the most common:
- A lower rate or payment. If market conditions or your credit profile have changed since you got your loan, a new loan may offer better terms. It also may not.
- A different loan term. Some homeowners move to a shorter term to pay the loan off sooner. Others move to a longer term to lower the monthly payment.
- Switching from an adjustable rate to a fixed rate. This can trade the chance of future rate changes for a payment that is more predictable.
- Removing a co-borrower. Refinancing into one borrower's name is one common way to take someone off the loan. Taking a name off the loan and taking it off the title are separate steps, so a real estate attorney can explain how that works where you live.
- Dropping mortgage insurance on some loans. On certain loans, mortgage insurance may not come off without replacing the loan. The rules depend on the loan type. Read how private mortgage insurance works and how to drop it before assuming a refinance is the only route.
If rate headlines are what got you thinking, what actually changes on your loan when rates move explains how news connects to the loan you already have.
A Refinance Has Closing Costs Too
A refinance is a new loan, so it usually comes with many of the same kinds of costs you saw when you bought. Common ones include:
- Lender fees, such as origination or underwriting charges
- An appraisal, if the lender requires one
- A title search and a lender's title insurance policy, plus settlement or closing agent fees
- Recording fees and, in some states, taxes on the new mortgage
- Prepaid items, such as interest and the money needed to set up a new escrow account for taxes and insurance
The total varies widely by lender, loan size, property and state. Your Loan Estimate lists the expected costs, and the guide to reading a Loan Estimate section by section walks through each part.
Three Ways to Pay Them
- Pay them upfront at closing. This keeps your loan balance lower, but it takes cash.
- Roll them into the loan. Where the lender allows it and you have enough equity, costs can be added to the new balance. You bring less to closing, but you borrow more and pay interest on those costs over time.
- Accept a higher rate in exchange for lender credits. A lender may offer credits that cover some or all of the costs in exchange for a higher interest rate. Less cash today often means a higher cost over the life of the loan.
None of these makes the costs disappear. Each one just moves them somewhere else. An offer that seems to have little or nothing due at closing typically works one of these ways, so ask where the costs went.
Closing costs don't vanish. Paying upfront, rolling them in or taking lender credits only changes when and how you pay them.
The Break-Even Math
The break-even point is roughly how long it takes for your monthly savings to cover the cost of refinancing. The basic method is simple:
Total refinance costs ÷ monthly savings = approximate months to break even
A Hypothetical Example
Here's an example using round, made-up numbers. It is a hypothetical only. Your numbers will differ.
- Hypothetical total refinance costs: $6,000
- Hypothetical monthly savings on principal and interest: $200
- $6,000 ÷ $200 = 30 months
In this hypothetical, it would take about 30 months for the savings to cover the costs. If the homeowner sold or refinanced again before then, the refinance would likely have cost more than it saved. If they kept the loan well past that point, the savings would keep adding up after break-even.
Use the Right Numbers
- Compare like with like. Compare principal and interest on the old loan with principal and interest on the new one. Property taxes and insurance generally don't change because you refinanced, so leave them out of the savings figure.
- Count every cost. Costs rolled into the loan still count. If lender credits cover the costs, the higher rate shows up as smaller monthly savings instead.
- Leave out the escrow refund. A refund of your old escrow balance is your own money coming back, not savings from the refinance.
Look at Total Interest, Not Just the Payment
The break-even shortcut focuses on the monthly payment. That's useful, but it can hide something important. If your new loan starts a fresh full term, you may lower your payment while pushing your payoff date further out.
Restarting the clock means more months of interest. Depending on how far into your current loan you are, the total interest you pay over the time you keep the loan could go up even though the monthly payment goes down.
A fairer comparison asks one question: over the time you actually expect to keep this loan, how much interest and cost would you pay with your current loan compared with the new one? A licensed loan officer can run that side-by-side for the time frame you choose. Some homeowners ask about a term closer to the time left on their current loan so they don't stretch things out.
A lower payment isn't the same as a lower cost. Resetting the term can mean paying more interest overall.
How Long You Plan to Stay Matters
Break-even only matters if you keep the loan long enough to reach it. A few questions to think through:
- Could you sell or move in the next few years?
- Might you refinance again if market conditions change?
- Could a job change or another planned event change your timeline?
If there's a real chance you'll sell or refinance before the break-even point, the math may not work in your favor.
You'll Need to Qualify Again
A refinance is a new loan, so the lender generally reviews your finances again. That often includes:
- Credit. Your credit history and scores can affect whether you qualify and what terms you're offered.
- Income and employment. Expect to document your current income.
- Debt-to-income ratio. Lenders compare your monthly debt payments with your income.
- Home value and equity. Many refinances require an appraisal. If the home's value has dropped, or you have less equity than you expected, your options may narrow.
Some government-backed loans, such as certain FHA and VA loans, offer streamlined refinance options for existing borrowers. These may involve less documentation and, in some cases, no new appraisal. Eligibility rules apply and can change, so ask a licensed loan officer whether one may fit your loan.
All loans are subject to qualification and lender approval.
Compare More Than One Lender
Rates, fees and lender credits can vary from one lender to the next, even on the same day. Getting a Loan Estimate from more than one lender is one of the most practical ways to see the trade-offs side by side.
When you compare:
- Request estimates around the same time, for the same loan type, term and amount, so they line up
- Compare total closing costs, not just the interest rate
- Check whether points or lender credits are included
- Review the Comparisons section of each Loan Estimate, which shows what you would pay over the first five years
- Ask your current lender or servicer about its options too, and compare them the same way
Timing and Rate Locks
Once you choose a lender, you can usually lock your rate for a set period while the loan is processed. If the lock expires before closing, extending it may cost extra, or the rate may change. Learn more about how a mortgage rate lock works and what can still change.
What Happens at Closing
The Right of Rescission
Under the federal Truth in Lending Act, many refinances of a primary residence come with a right of rescission. This generally gives you until midnight of the third business day after closing, or after you receive the required notices and disclosures if that comes later, to cancel the new loan. Because of this, loan funds generally aren't disbursed until the period ends.
The right generally doesn't apply to second homes or investment properties. It may also be limited when you refinance with your current lender and don't borrow additional money. Your closing agent can confirm whether it applies to your loan.
Paying Off the Old Loan
The closing agent typically requests a payoff statement from your current servicer. The payoff amount usually includes the remaining balance plus interest owed through the payoff date, since mortgage interest is generally paid after it builds up. That's why it can feel like you skip a payment during a refinance. The interest is still paid. It's handled through the payoff and the new loan.
Keep paying your current loan as scheduled until your servicer confirms it has been paid off.
Your Escrow Account
If your current loan has an escrow account for taxes and insurance, the old servicer typically refunds any remaining balance after the loan is paid off. Your new loan may require funding a new escrow account at closing, which is one reason prepaid items can add up.
Frequently Asked Questions
Is there a rule of thumb for when refinancing is worth it?
You may hear rules of thumb about how much rates should drop. They don't account for your costs, your loan or your plans. The break-even method and a total-interest comparison, using figures from your own Loan Estimates, usually tell you more.
Can I refinance with my current lender?
Often, yes. Your current lender or servicer may offer refinance options. It still makes sense to compare its Loan Estimate with offers from other lenders.
Does applying to refinance affect my credit?
Applying generally involves a credit check, which may have a small, temporary effect on scores. Many credit scoring models treat several mortgage inquiries within a short window as a single inquiry, which is one reason to do your comparison shopping in a focused period.
The Bottom Line
A refinance can lower your payment, change your term or switch your loan type. But it comes with closing costs, and it means qualifying again. Add up the full cost, divide by your monthly savings to find a rough break-even, and compare total interest over the time you actually expect to keep the loan. Then compare Loan Estimates from more than one lender before you decide.
This article is general information, not lending, legal or tax advice. Rules vary by state and loan program, and rates, terms and costs vary by lender. All loans are subject to qualification and lender approval. Talk with a licensed loan officer about your situation. Advice4Homeownership is a publisher, not a lender.
