Mortgage Refinance: You Have to Think Long-Term

When it comes to a mortgage refinance, it’s less about how much you’ll spend and more about how long you’ll stay.

Your mortgage lender can help you figure out if it's worth it to refinance. Image: Neighborhood Centers, Inc.

It’s generally a good time for a mortgage refinance when:

  • Mortgage rates drop at least 1% below your current rate.
  • You’re planning to stay in your house long enough to justify the closing costs.

Do the math

No. 2 above requires some calculation on your part. To figure it out, you’ll need to know:

  • The closing costs for a new loan. Ask potential lenders—costs usually run 3% to 6% of the loan amount. Lenders may finance these costs (that is, fold them into your loan amount), so you don’t actually have to write a check, but you’re still paying for it.
  • Your current mortgage payment.
  • Your potential new payment. Again, your lender can give you this.
  • The length of time you plan to keep your home.

To simplify these calculations, do a quick search online for various free mortgage refinance calculators, which can be found on many bank sites.

Find your breakeven point

Here’s an example of how a mortgage refinance might play out with a typical 30-year fixed-rate mortgage:

Amount refinanced $200,000
Closing costs for new loan 4%, or $8,000
Current mortgage 6%, or $1,199 per month
New mortgage 5%, or $1,074 per month
Monthly savings $125

But even though you start paying the lower rate right away, you’ve shelled out $8,000 in closing costs, and you aren’t ahead of the game on your mortgage refinance until you’ve paid that off. At $125 in monthly savings you have to stay in your home 64 months—more than five years—to make it worth it ($125 x 64 months = $8,000). Move before then, and you’ve lost on the deal.

However, if you remain for 10 years, for example, you’ll have saved $7,000.

It gets better

Although 1% is the rule-of-thumb minimum for a mortgage refinance, lower rates can make refinancing even more attractive, as the breakeven period becomes shorter.

Consider the above mortgage refinance scenario if you could shave another half-point:

Amount refinanced $200,000
Closing costs for new loan 4%, or $8,000
Current mortgage 6%, or $1,199 per month
New mortgage 4.5%, or $1,013 per month
Monthly savings $186

You now reach the breakeven point in just over 3.5 years.

Another way to improve your position

Two additional factors can make a mortgage refinance an even better option:

  • Your credit rating has improved since your last mortgage. Go to AnnualCreditReport.com to monitor improvements.
  • You’ve started earning more money.

Both these factors make you a more desirable candidate in lenders eyes’ for a mortgage refinance, possibly allowing you to negotiate lower interest rates or lower closing costs, further shortening your breakeven period.

The bottom line is that you shouldn’t seek out a mortgage refinance just because “everyone is doing it.” It needs to make financial sense for you.