When refinancing makes sense: costs, break-even and goals

Start with your goal

The CFPB suggests refinancing only to meet an important financial goal. It describes three common ones:

1. Lower your rate and payment. The trade-off, the CFPB notes, is that a new loan may have a longer term, which can mean lower payments but more paid in total.
2. Shorten the term. Paying off sooner usually means less total interest but a higher monthly payment.
3. Avoid a payment jump on an adjustable-rate loan. Moving to a fixed rate may raise the payment now but makes it predictable.

A fourth reason is a cash-out refinance, which the Federal Reserve's consumer guide describes as borrowing more than you owe and taking the difference in cash. That adds to your debt and puts your home on the line for it.

When it may not make sense

The CFPB lists four warning signs. If any apply, refinancing may not be worth it:

• You plan to move soon and may not have time to recover the costs.
• Your home's value has fallen, which can make a better loan harder to find.
• Your credit has declined, which affects the rate you are offered.
• Your mortgage has a prepayment penalty, which you would pay when you refinance.

The Federal Reserve's guide adds another: refinancing late in a mortgage restarts amortization, so more of each payment goes to interest again rather than building equity.

Calculating break-even

Break-even answers one question: how long until the monthly savings add up to the cost of refinancing? Divide the total costs by the monthly savings.

If the refinance costs $6,500 and saves $250 a month, the break-even is 26 months. If you expect to keep the loan longer than that, the savings eventually outweigh the costs. If not, they may not.

Use the costs from a Loan Estimate, which lists them in detail, and include any prepayment penalty. If a lender offers to cover costs through a lender credit, the rate will be higher, so compare that option too.

Watch the total, not just the payment

A lower payment is not the same as a lower cost. If you have 27 years left on your loan and refinance into a new 30-year loan, you add three years of payments. The CFPB's handout illustrates exactly this: lower payments for more years can mean a higher total cost.

The calculator below compares the total of your remaining payments with the total of the new loan's payments plus its costs. You can also ask lenders for a custom term. The CFPB notes that terms such as 22 years are often possible, which can lower the rate without extending the payoff date.

Getting offers

• Ask at least two lenders for Loan Estimates on the same day.
• Ask for options with no points, with points and with lender credits.
• Ask whether your current servicer offers a streamlined refinance for your loan type.
• Check whether your new loan will need mortgage insurance, or whether you can drop it.

The bottom line

Refinancing makes sense when it serves a clear goal and you will keep the new loan long enough to recover its costs. Check the CFPB's warning signs first, calculate break-even with the costs on a Loan Estimate and compare total cost, not just the monthly payment, before you sign.