The break-even point
Refinancing costs money up front: lender fees, appraisal, title insurance and recording, usually 2% to 5% of the loan. The monthly saving has to pay that back before you are ahead.
Break-even (months) = closing costs ÷ monthly savings
$6,500 of costs and a $250 lower payment break even in 26 months. If you sell or refinance again before then, you lose money. This calculator goes one step further and compares the two loans month by month, including the different amounts of principal you pay down, which is more accurate than the simple formula when the term changes.
The term trap
Refinancing a loan with 27 years left into a new 30-year loan lowers the payment partly because you are spreading the balance over three extra years. The monthly saving looks bigger than the rate cut alone would give, and total interest can rise even at a lower rate. Compare the lifetime interest line, or choose a term close to the years you have left.
Is there a rule of thumb?
The old advice was to refinance when you can cut your rate by at least one percentage point. With higher balances today, even 0.5 to 0.75 points can be worth it if you will stay long enough to pass the break-even point. The real test is the net gain over the time you expect to keep the loan, shown above.
Points and no-closing-cost loans
A discount point costs 1% of the loan and typically lowers the rate by about 0.25 points. It pays off only if you keep the loan for many years. A no-closing-cost refinance does the opposite: the lender covers the costs in exchange for a higher rate, which suits people who may move or refinance again soon.
Cash-out refinancing
A cash-out refinance replaces your mortgage with a larger one and pays you the difference. Lenders usually cap the new loan at 80% of the home's value. It can be a cheap way to fund renovations or clear expensive debt, but it turns short-term debt into 30-year debt secured on your home. A HELOC may cost less if your current rate is low.