A mortgage refinance is not always a money-saving proposition. It should be. To know that a refi is a smart financial move, you’ll have to do a small but easy calculation, and consider more than just the interest rate. 

Here is how to calculate your break-even point on a mortgage refinance.

See today’s best refinancing rates.

What is a break-even point on a mortgage refinance?

The break-even point for a mortgage refinance is when the monthly savings of a lower payment equal the refinance costs. You wouldn’t normally want to move from a home before you recoup the costs of the new loan you obtained.

Here is the formula:

Total refinancing costs / Monthly savings = Number of months to break-even point

Freddie Mac, one of the government-sponsored companies that provides capital to the home-lending market, estimates that refinancing a mortgage costs 3% to 6% of the loan principal. 

Using 3% closing costs as an example, let’s assume a $200,000 loan balance with 20 years remaining on the original term. The current interest rate is 7%, and the borrower is refinancing to 5% with the same 20-year term. 

• The original principal and interest payment each month totals $1,551.00 at 7%.

• The 5% refinance will have monthly P&I payments of $1,320.

• Monthly savings equal $231.

• With 3% closing costs of $6,000, it will take about 26 months to break even on the refinance.

The calculation: 6000 / 231 = 25.97

Read more: Types of refinancing options

There’s a long list of refinance costs

If it’s been a while since you closed your original loan, you may have forgotten (probably not) the large pile of loan fees and closing costs, which can include:

• Loan origination and underwriting fees

• Application fees

• Discount points (optional)

• Title insurance and title search fees

• Appraisal

• Recording fees

• Credit report fees

• Escrow services

If you roll your closing costs into your new refinance loan, or a lender offers a “no-closing-cost refinance,” you will likely have a higher interest rate and/or additional debt to finance. Those will impact your break-even point.

Read more: How much does it cost to refinance a mortgage?

Consider the loan term and your long-term plans

You can break even faster by extending your term. For example, in the scenario above, refinancing with a new 30-year term, rather than 20 years, lowers your payment even more, and your break-even point is only 13 months.

The downside: You are paying so much more interest over the life of the loan because of the additional 10 years tacked on.

However, if you plan on moving to another home sometime after the break-even point and before the end of the 30-year term, you may make the numbers work in your favor. 

Not all refinances have the same break-even point

As mentioned above, financing your closing costs will extend your break-even point. Another example: a cash-out refinance. You are taking some of your equity out of the home and adding it to your new loan, so your monthly payment will be larger than with a simple refinance. 

Read more: Pros and cons of refinancing

Break-even point on a refinance: FAQs

What is a good break-even point for refinance?

A good break-even point for a mortgage refinance depends on how long you intend to remain in the home. If you’re likely to stay there for three years or more, then a break-even point of 18 to 24 months might work. It’s best to do the break-even calculation noted above to best consider your options. 

What is the 2% rule for refinancing?

The 2% rule says you should refinance when you can earn a 2-percentage-point reduction in your interest rate, say, from 7% to 5%. However, as with so many ‘rules of thumb,’ the answer is much too simplistic. Much of the decision on when to refinance hinges on how large your mortgage balance is and how long you intend to remain in the home. Borrowers today may benefit from interest rate reductions of just a half-point or more. It’s another decision guided by math and circumstance.

Is it worth refinancing from 7% to 6%?

It absolutely can be. A one percentage point improvement in your mortgage interest rate can lower your monthly payments significantly, especially with larger loan balances. Just resist the temptation to extend your loan term beyond the current time to pay off. That adds interest and more debt to the new loan.

What is the 80/20 rule for refinancing?

The 80/20 rule is a common equity benchmark lenders use. Many lenders will allow you to borrow up to 80% of your home’s value, meaning you have 20% equity in your home.