When Does Refinancing Your Mortgage Actually Make Sense?

Interest rates dropped and your neighbor just refinanced. Should you? Maybe—but "rates are lower" isn't enough reason on its own. Here's a framework for making the right call.

The Break-Even Question

Refinancing costs money upfront (closing costs) to save money over time (lower monthly payment). The key question is: How long until the savings exceed the costs?

Break-Even Formula

Break-even months = Closing costs ÷ Monthly savings

Example: $6,000 in closing costs ÷ $200/month savings = 30 months to break even

If you plan to stay in your home longer than the break-even period, refinancing likely makes sense. If you might move sooner, you'll lose money.

The Old "1% Rule" Is Outdated

You may have heard that you should refinance if rates drop by 1%. This rule is too simplistic because it ignores:

Your remaining loan balance
How long you plan to stay
Closing costs in your area
The new loan term

A 0.5% rate drop might be worth it on a large loan. A 1.5% drop might not be worth it if you're moving in two years. Do the math for your specific situation.

Common Refinancing Scenarios

1. Rate-and-Term Refinance

The most common type: you get a lower rate and/or shorter term, reducing your total interest paid. This makes sense when:

Rates have dropped 0.5-1%+ from your current rate
You'll stay long enough to pass break-even
You're not extending your payoff date significantly

2. Cash-Out Refinance

You borrow more than you owe and pocket the difference. This can make sense for:

Home improvements that add value
Consolidating high-interest debt (carefully!)
Major expenses with no better financing option

Caution: You're putting your home at risk. Don't cash out for vacations, cars, or lifestyle inflation.

3. ARM to Fixed

If you have an adjustable-rate mortgage and rates have risen (or you expect them to), locking in a fixed rate provides payment stability. Worth considering if you plan to stay long-term.

Hidden Costs to Watch

Closing costs typically run 2-5% of the loan amount. Make sure to account for:

Origination fees: 0.5-1% of loan
Appraisal: $300-600
Title insurance: $500-2,000+
Recording fees: $50-250
Prepaid interest: Varies

Watch Out for "No-Cost" Refinancing

There's no free lunch. "No closing cost" loans either roll fees into your balance (so you pay interest on them) or charge a higher rate. Calculate the true cost over your expected ownership period.

The Term Length Trap

Be careful about the new loan term. If you've paid 7 years on a 30-year mortgage and refinance into a new 30-year loan, you're restarting the clock. Even with a lower rate, you might pay more in total interest.

Better approach: Refinance to a term that matches your remaining years, or shorter. Going from 23 years remaining to a 20-year loan is ideal.

When NOT to Refinance

You're moving within the break-even period
Your credit score has dropped significantly
You've lost income and might not qualify
You're close to paying off your current mortgage
The rate drop is minimal (under 0.5%)
You'd extend your payoff date significantly

The Decision Framework

Calculate your break-even point using actual quotes from lenders
Estimate how long you'll stay in your home (be conservative)
Compare total costs over your expected stay, not just monthly payment
Consider the opportunity cost of closing costs invested elsewhere
Get multiple quotes—rates and fees vary significantly between lenders

The Bottom Line

Refinancing can save tens of thousands over the life of your loan—or cost you money if done at the wrong time. The decision isn't about what rates are doing; it's about the math of your specific situation.

Run the numbers before you call a lender. Know your break-even point. And never refinance just because everyone else is.