What is Mortgage Refinancing?
Refinancing means replacing your existing mortgage with a new one — typically to get a lower interest rate, change your loan term, switch from ARM to fixed (or vice versa), or tap into your home equity. It is essentially taking a new loan to pay off the old one.
Refinancing costs 2-5% of the loan amount in closing costs, so it only makes sense if the savings outweigh those costs. The key is calculating your breakeven point.
When Refinancing Makes Sense
- Rate drop of 0.75-1% or more — The traditional rule says refinance when rates drop at least 1%. But even 0.5-0.75% can make sense if you have a large loan balance and plan to stay long-term
- Breakeven calculation — Divide total closing costs by monthly savings. If closing costs are $6,000 and you save $200/month, breakeven is 30 months. If you plan to stay 5+ years, it is worth it
- Switch from ARM to fixed — If your ARM adjustment period is approaching and rates are reasonable, locking into a fixed rate provides stability
- Shorten your term — Refinancing from a 30-year to a 15-year loan can save you hundreds of thousands in interest, though your monthly payment increases
- Remove PMI — If your home has appreciated and you now have 20%+ equity, refinancing can eliminate PMI payments ($150-$300/month)
- Cash-out refinance — Access your home equity for major expenses (renovations, debt consolidation, education). You get a larger loan and receive the difference in cash
When NOT to Refinance
- You plan to move soon — If you will sell within 2-3 years, you likely will not reach breakeven on closing costs
- You have had your mortgage a long time — If you are 20 years into a 30-year mortgage, most of your payment goes to principal. Refinancing restarts the interest-heavy early years
- Your credit has dropped — Lower credit score means higher rates. Fix your credit first, then consider refinancing
- Closing costs are too high — If breakeven is 5+ years, the savings are not compelling enough given the uncertainty
- To fund lifestyle — Cash-out refinancing to pay for vacations or cars converts unsecured spending into 30-year secured debt on your home. Avoid this
Refinance Savings Example
- Current mortgage — $350,000 remaining, 6.8% rate, 25 years left = $2,451/month
- Refinance to — $350,000, 5.8% rate, 30-year term = $2,055/month
- Monthly savings — $396/month ($4,752/year)
- Closing costs — $8,000
- Breakeven — 20 months
- If you stay 10 years — Net savings after closing costs: $39,520
Warning: While this reduces your monthly payment, extending back to 30 years means you pay more total interest over the life of the loan. Consider refinancing to a shorter term if you can afford the payments.