A lower mortgage rate can make refinancing look attractive, but the rate alone does not tell the whole story.
Refinancing means replacing an existing mortgage with a new one. The goal may be to lower the monthly payment, reduce the interest rate, change the loan term, switch from an ARM to a fixed-rate mortgage or access home equity. But refinancing usually has costs, and those costs can erase the benefit if the homeowner sells or refinances again too soon.
Freddie Mac’s refinance calculator is designed to help homeowners estimate whether refinancing may make sense, while noting that borrowers should contact a lender for precise calculations.
Key takeaways
- Refinancing replaces an existing mortgage with a new mortgage.
- A lower rate is not enough; closing costs matter.
- The break-even point shows how long it takes monthly savings to recover refinance costs.
- A refinance can lower payment, shorten term or change loan type.
- Extending the loan term can reduce monthly payment but increase total interest.
- Some refinances have a three-business-day right of rescission.
- Homeowners should compare total cost, not just monthly savings.
What a refinance calculator should show
A good refinance calculator should estimate more than the new monthly payment.
It should help compare current loan balance, current interest rate, current monthly payment, new interest rate, new loan term, refinance closing costs, monthly savings, break-even point, total interest and how long the homeowner expects to keep the loan.
Fannie Mae’s refinance calculator is designed to estimate how much money a homeowner could save each month by refinancing.
But calculators are only as accurate as the numbers entered. Homeowners should use lender quotes, not guesses.
The break-even point
The break-even point is the most important refinance calculation.
The formula is simple:
Refinance closing costs ÷ monthly savings = months to break even
Example:
- Refinance closing costs: $6,000
- Monthly savings: $250
- Break-even point: 24 months
In that example, the homeowner needs to keep the new loan for at least two years before the refinance begins producing net savings.
The Federal Reserve’s consumer guide to mortgage refinancing explains that monthly savings from lower payments may not exceed the costs of refinancing and that a break-even calculation can help determine whether the refinance is worthwhile.
When refinancing may make sense
Refinancing may make sense when the new rate is meaningfully lower, monthly savings are large enough, the break-even period is shorter than the expected time in the home, the borrower wants to switch from an ARM to a fixed-rate loan, the borrower wants to shorten the loan term, the borrower can remove mortgage insurance, or the borrower needs to restructure debt carefully.
The CFPB says homeowners often refinance to try to lower the cost of their mortgage, but there are tradeoffs and questions to consider.
When refinancing may not make sense
Refinancing may not make sense when closing costs are too high, the homeowner expects to move soon, the loan term resets and increases long-term interest, payment savings are small, the borrower’s credit or equity has weakened, or the homeowner is refinancing mainly because of marketing pressure.
A refinance that lowers the monthly payment by extending the loan term can still increase total interest paid over time. That is not always bad, but the homeowner should understand the tradeoff.
No-closing-cost refinance is not free
Some lenders advertise no-closing-cost refinancing. That usually means the costs are rolled into the loan balance or offset through a higher interest rate.
The CFPB explains that points and lender credits create tradeoffs between upfront closing costs and the interest rate. Lender credits can lower upfront costs in exchange for a higher rate.
Right of rescission
Some refinance transactions come with a right of rescission.
The CFPB says that if a borrower is refinancing a mortgage, they generally have until midnight of the third business day after the transaction to rescind, or cancel, the mortgage contract. This right does not apply to a mortgage used to buy a home once closing documents are signed.
What this means
Refinancing should be treated as a math decision and a life-plan decision.
A homeowner should compare the new monthly payment, closing costs, break-even point, loan term, total interest and expected time in the home. A lower rate is helpful only if the savings outweigh the costs during the period the homeowner expects to keep the loan.
FAQ
When should I refinance?
Refinancing may make sense when the monthly savings and loan benefits outweigh the closing costs before you expect to sell or refinance again.
What is a refinance break-even point?
The break-even point is how long it takes monthly savings to recover the upfront cost of refinancing.
Is a lower mortgage rate always worth refinancing?
No. A lower rate may not be worth it if closing costs are high or if you plan to move before reaching the break-even point.
What does a refinance calculator miss?
Some calculators may understate closing costs, loan-term reset effects, taxes, insurance, points and lender credits.
Can I cancel a refinance after closing?
For certain refinance transactions, the CFPB says borrowers generally have until midnight of the third business day after the transaction to rescind.
Sources
- Freddie Mac Refinance Calculator
- Fannie Mae Mortgage Refinance Calculator
- CFPB Should I Refinance?
- Federal Reserve Consumer’s Guide to Mortgage Refinancing
- CFPB Lender Credits and Points
- CFPB Right of Rescission
