Why the usual break-even number is wrong
Ask any lender when a refinance pays for itself and you will get the same
arithmetic. Closing costs divided by monthly savings. Six thousand dollars of
costs against two hundred dollars a month saved gives thirty months, so anything
past two and a half years is profit.
That calculation quietly ignores the part of your payment that is not a cost
at all. Every month a chunk of your payment reduces what you owe, and that
chunk is money moving from one pocket to another rather than money leaving. When
you refinance into a fresh thirty year term, your new payment is smaller partly
because the interest rate dropped and partly because you have stretched the
payoff back out to thirty years. The first reason is a genuine saving. The
second is a deferral dressed up as one.
This calculator compares the two loans the honest way. At every month it adds
up what you have paid out so far and what you still owe, for both loans. The
break-even point is the month the new loan's total position first beats the old
one. Nothing gets credited as a saving unless it actually leaves you better
off.
What the difference looks like
Take a $285,000 balance at 7.125 percent with 26 years left, refinanced to
6.125 percent over a fresh 30 years, $6,200 of costs rolled in.
| Method | Break-even | What it counts |
|---|
| Costs divided by savings | roughly 2 to 3 years | Only the drop in the monthly payment |
| Total cost including balance | meaningfully longer | Payments made plus what you still owe |
Both numbers are in the calculator so you can see the gap for your own loan.
The shortcut is not useless, it just answers a narrower question, namely how
long until your cash flow recovers the fee. That matters if cash flow is the
reason you are refinancing. It is the wrong number if you are trying to work out
whether you come out ahead.
The amortization reset, and how to avoid it
A mortgage front loads interest. In the first years almost all of your
payment is interest and barely any touches the principal. By year eight the
split has shifted and you are finally making real progress on the balance.
Refinance into a new thirty year term and you go back to the start of that
curve. The rate is lower, but you are once again paying mostly interest, and the
years of progress you made on the principal schedule are gone. You keep the
equity you built, you just restart the clock on how fast the rest arrives.
The fix is simple and almost nobody is offered it. Match your new
term to the years you have left. If 26 years remain, ask for a 25 year
term rather than accepting the default 30. The payment will be slightly higher
than the 30 year quote and dramatically lower in lifetime interest. Many lenders
will write any term you ask for, including odd ones like 23 years, because the
pricing barely differs.
If your lender will not budge, the workaround is to take the 30 year note and
pay it as though it were a 25 year one. Set the extra principal up as an
automatic transfer. You get the flexibility of the lower required payment with
the payoff schedule you actually wanted.
Rolling closing costs into the loan
Financing your closing costs feels free because nothing leaves your bank
account at signing. What you have really done is borrow the fee at your mortgage
rate for as long as the loan runs.
Six thousand dollars added to a 30 year loan at 6.125 percent costs roughly
$13,000 by the time it is paid off. The calculator shows this figure separately
so the choice is visible rather than buried. Sometimes rolling it in is still
right, particularly if paying cash would drain your emergency fund. Just make
the trade knowingly.
Watch out for the phrase no closing cost refinance. There is
no such product. Either the fees are added to your balance or the lender covers
them in exchange for a higher rate, which you then pay every month for decades.
The second version can genuinely be the better deal on a loan you expect to
refinance or pay off soon, and the calculator handles it if you enter zero costs
with the higher rate you were quoted.
Discount points
A point costs one percent of the loan and typically buys the rate down by
about a quarter point, though the exchange rate moves with the market. Points
have their own break-even, and it is usually much longer than people expect,
often somewhere between five and eight years.
Points only make sense when you are confident you will keep the loan a long
time. Sell or refinance before the break-even and the money is simply gone. Note
that points are prepaid interest, so if you itemize they are deductible, but on
a refinance they have to be spread across the life of the loan rather than
deducted all at once.
When dropping mortgage insurance changes everything
If you are paying PMI, a refinance can be worth doing even without much of a
rate improvement. Once your equity passes 20 percent, a conventional refinance
removes the insurance premium entirely, and a couple of hundred dollars a month
is a real saving with no offsetting cost.
FHA loans are the strong case here. If your FHA loan was taken with less than
10 percent down, the monthly insurance runs for the life of the loan and never
falls off no matter how much equity you build. Refinancing into a conventional
loan is the only way to escape it, and for many FHA borrowers that alone
justifies the move.
Before you refinance purely for PMI, check whether you can just request
removal. On a conventional loan you can ask once the balance reaches 80 percent
of the original value, and it becomes automatic at 78 percent. That route costs
you an appraisal fee at most. The calculator estimates when your current loan
reaches that point so you can compare waiting against refinancing.
Cash out refinancing
A cash out refinance replaces your mortgage with a larger one and hands you
the difference. Because you are increasing the balance, your payment usually
rises even when the rate falls, so break-even in the normal sense does not
apply. What you are really comparing is the mortgage rate against whatever the
money would otherwise cost you.
Against credit card debt in the twenties, that trade is usually
straightforward. Against a HELOC or simply leaving the equity alone, it is much
closer, and you are converting unsecured debt into debt secured by your house.
Expect a slightly higher rate on cash out than on a rate and term refinance, and
expect lenders to want you to leave at least 20 percent equity behind.
The old rules of thumb, and why they fail
- Wait for a 1 percent rate drop. Arbitrary. On a $700,000
balance a quarter point is worth refinancing. On an $80,000 balance a full point
barely covers the fees.
- Never refinance in the last ten years. Usually right,
because you will be moving mostly principal by then, but shortening the term or
killing PMI can still win.
- Always take the lowest payment. The lowest payment often
means the longest term and the most total interest.
- Refinancing restarts your mortgage. Only if you let it. Ask
for a term that matches what you have left.
Your loan size, your remaining term and how long you will stay decide the
answer, which is exactly what the calculator uses.
Before you apply
- Get a written Loan Estimate from at least three lenders. It is a
standardised form, so page two lines up across all of them.
- Compare the total of section A through C, not the advertised rate.
- Ask each lender to quote a term matching your remaining years.
- Ask whether the rate assumes points, and get the no points rate too.
- Apply to all of them inside a 45 day window. Mortgage enquiries in that
period count as a single hit to your credit score.
- Check for a prepayment penalty on your existing loan before you sign
anything.
This calculator is an educational estimate and not financial, tax or lending
advice. Results use the figures you enter and assume a fixed rate with no
prepayment penalty, no escrow changes and payments made on schedule. Your actual
costs, rate, mortgage insurance and eligibility depend on the lender, your
credit, the property and current market pricing. Always compare official Loan
Estimates from multiple lenders before deciding, and speak to a tax professional
about the interest and points deduction.
