The break-even calculation
A refinance is a new mortgage that pays off the old one, and it comes with closing costs of 2 to 5 percent of the loan. Divide the total cost by the monthly savings to get the break-even point in months. Costs of $4,500 against savings of $150 a month take thirty months to recover. The old rule about waiting for rates to fall a full point is only a rough guide, since half a point can pay on a large loan and two points may not on a small one.
The term trap
Seven years into a thirty-year loan, a new thirty-year loan lowers the payment partly by stretching twenty-three years of remaining debt over thirty. Total interest can rise even at a lower rate. There are two remedies. Refinance into a twenty- or fifteen-year term, which usually carries a lower rate as well, or take the new thirty-year loan and keep paying the old amount, so that the difference goes to principal.
Reasons beyond the rate
- A move from an FHA loan to a conventional one can end mortgage insurance once you hold 20 percent equity.
- A move from an adjustable rate to a fixed one makes sense before the rate resets.
- A cash-out refinance lets you borrow more than you owe and keep the difference, at a somewhat higher rate. It converts ordinary spending into debt secured by your home, which is defensible for a renovation and poor for a vacation or a car.
If your existing mortgage carries a very low rate, a home equity loan or line of credit raises cash without disturbing it.
Doing it well
A no-closing-cost refinance still has costs, paid through a higher rate or added to the balance, and it suits someone who expects to move or refinance again within a few years. Request Loan Estimates from at least three lenders, your current servicer included, on the same day, because rates move daily. Mortgage inquiries made within a short window count as one on your credit. Expect to supply pay stubs, two years of W-2s and bank statements, and allow thirty to forty-five days. Keep paying the old loan until the new one closes, and open no new credit in the meantime.
Tip Ask your servicer about a recast before you refinance. You pay a lump sum toward principal, the servicer recalculates the payment for a fee of a few hundred dollars, and the rate and term stay as they were.
