Key takeaways
- Break-even is closing costs divided by monthly savings — and only counts if you keep the loan that long.
- Refinancing into a new 30-year term can lower payments while increasing lifetime interest.
- Cash-out refinances price worse than rate-and-term and reset your entire balance at the new rate.
- The old '1% rule' is not a rule; the arithmetic depends on balance, costs, and horizon.
Two different transactions
A rate-and-term refinance replaces your existing loan with a new one at a different rate or term without taking equity out. A cash-out refinance replaces it with a larger loan and pays you the difference. Lenders price these differently, with cash-out carrying meaningful adjustments.
The distinction matters beyond price. A cash-out refinance applies the new rate to your entire balance, not just the cash extracted. If you hold a low-rate mortgage and need $60,000, a home equity loan or HELOC that leaves the first mortgage untouched is frequently cheaper. See HELOC versus home equity loan.
Computing break-even honestly
Divide total closing costs by the monthly payment reduction. That is the number of months you must keep the loan to come out ahead. If costs are $6,000 and you save $220 monthly, break-even is about 27 months.
The complication is term. Comparing a new 30-year loan against a 30-year loan you have already paid seven years into is not apples to apples — you are re-amortizing over a longer remaining period, which lowers the payment partly because you extended it. Compare against a matched remaining term, or compare total remaining interest. Our refinance calculator shows both.
When refinancing makes sense and when it does not
Good cases: a materially lower rate with a horizon well beyond break-even; removing FHA mortgage insurance after reaching 20% equity; converting an adjustable-rate loan to fixed before adjustment; shortening from 30 to 15 years when cash flow allows.
Bad cases: refinancing repeatedly and resetting amortization each time; extracting equity for depreciating consumption; refinancing shortly before selling; and refinancing to consolidate unsecured debt without addressing the behavior that created it — you have converted dischargeable debt into debt secured by your house.
Frequently asked questions
Is there a rate drop that automatically justifies refinancing?
No. A 0.5% drop on a $700,000 balance clears costs quickly; the same drop on a $120,000 balance may never. Run the arithmetic on your actual numbers.
What is a streamline refinance?
FHA, VA, and USDA offer streamlined programs with reduced documentation and often no appraisal, available only to existing borrowers in those programs. They are fast and cheap but limited to rate-and-term.
How soon can I refinance after buying?
Often immediately, though some lenders impose seasoning requirements and cash-out refinances generally require six to twelve months of ownership.
Sources & further reading
- Consumer Financial Protection Bureau, Refinancing your mortgage
- Fannie Mae Selling Guide B2-1.3, Loan Purpose
- FHA Streamline Refinance requirements, HUD Handbook 4000.1
Figures and rules change. Verify current requirements with the issuing agency or a licensed professional before acting.