When Does Refinancing Make Sense? A Simple Break-Even Guide

Every year around this time, I get the same question from past clients: "Should I be doing something with my mortgage?"

With rates staying elevated this fall, the honest answer for most people is: not just for the rate. But "not for the rate" is not the same as "never." There are good reasons to refinance that have nothing to do with chasing a lower number, and there's a simple way to know exactly when a refinance pays for itself.

Here's how I walk my own clients through it.

The break-even rule

A refinance costs money up front: lender fees, title, appraisal, recording and prepaid items. The question is how long it takes for the monthly savings to pay those costs back.

Closing costs ÷ monthly savings = months to break even

Illustration only: Say a refinance has $6,000 in closing costs and lowers your monthly principal and interest by $200. $6,000 ÷ $200 = 30 months to break even.

If you plan to stay in the home (and keep the loan) longer than 30 months, the refinance comes out ahead. If you might sell or refinance again within two and a half years, it probably doesn't.

A few things to keep in mind when you run your own numbers:

• Compare like with like. Restarting a 30-year clock lowers your payment partly because you're stretching the loan back out. Look at total interest over the time you'll actually keep the loan, not just the monthly payment.
• "No-cost" refinances aren't free. The costs are usually built into a higher rate or added to the balance. That can still be the right move, but count it.
• Escrow is not a cost. Prepaid taxes and insurance shift money around; they don't change whether the refinance pays off. Leave them out of the break-even math.

Reasons to refinance that aren't about the rate

1. Dropping mortgage insurance. If you bought with an FHA loan and less than 10% down, the mortgage insurance premium (MIP) usually stays for the life of the loan. With South Florida values up over the past few years, many FHA borrowers now have 20% or more in equity, enough to refinance into a conventional loan with no mortgage insurance at all. Sometimes that alone outweighs a higher rate. (On a conventional loan, you may be able to cancel PMI without refinancing. Ask your servicer first.)
2. Moving from an adjustable rate to a fixed rate. If you have an ARM that's approaching its first adjustment, locking in a fixed payment can be worth it for the peace of mind, even if the fixed rate isn't lower.
3. Cash-out for a real purpose. Pulling equity to pay off high-interest debt, fund a renovation that adds value, or consolidate a HELOC into one fixed loan. (If you only need a portion of your equity and you like your current first-mortgage rate, a HELOC or home equity loan may be the better tool. I covered that in last month's post.)
4. Taking someone off the loan. After a divorce, a separation or a family change, refinancing is often the only way to remove a co-borrower from the mortgage.

When not to refinance

• You're likely to move soon. If you won't reach your break-even point, skip it.
• Your loan is nearly paid off. Restarting a 30-year term when you have 8 years left can cost you far more in total interest, even at a lower rate.
• Your credit or income has taken a hit. It may be better to wait, clean things up and come back when you'll qualify for better terms.
• The savings are tiny. If the break-even is five-plus years out, the risk of life changing before then is real.

Investor sidebar: refinancing a rental with a DSCR loan

If you own rental property, a DSCR (debt service coverage ratio) loan qualifies based on the property's rental income instead of your personal tax returns. Investors use DSCR refinances to pull cash out of a rental for the next purchase, to move off a short-term or hard-money loan, or to get a property out of their personal debt-to-income picture. The break-even rule still applies; the focus is just on whether the rent comfortably covers the new payment.

Know your trigger point, even if now isn't the time

Here's the most useful thing you can do this year, even if refinancing doesn't make sense today: know the number. Work out roughly what rate or what situation would make a refinance worth it for you. Then, when the market moves or your life changes, you'll know in five minutes whether to act instead of guessing (or taking the word of a lender who cold-calls you).

Preguntas frecuentes

¿Quiere que le haga los números?

Send me your current rate, balance and what you're hoping to accomplish, and I'll tell you straight whether a refinance makes sense now, later or not at all. No cost, no pressure.

Frank Herrera · 305-299-6995 · frank@frankyourmortgageguy.com