Refinance break-even

Refinancing is marketed on the monthly saving, which is the least informative number in the whole transaction. A lower payment can come from a lower rate, or it can come from stretching the remaining balance back out over thirty years, and those two things have almost opposite effects on what you eventually pay.

The three questions, in order

1. Does the monthly saving recover the closing costs before you leave the loan? This is the break-even, and it is the gate. Fail it and nothing else matters.
2. What happens to lifetime interest? A lower rate on a fresh thirty-year term can still cost more overall than staying put, because you restart the amortisation clock.
3. Are you refinancing the same debt? Rolling closing costs into the balance, or taking cash out, means you are comparing two different loans, not two prices for one loan.

The term reset, which is where most of the money hides

Suppose you took a $360,000 thirty-year mortgage at 7.25% and have paid it for four years. The balance is around $342,000 and you have 26 years left. A refinance at 6.25% over a fresh thirty years drops your payment meaningfully, and adds four years of payments back on the end.

The middle row is the one lenders quote: $350 a month cheaper. It saves about $8,100 in interest over the life of the loan. The bottom row keeps the original payoff date and saves $65,600. Eight times as much, for $141 a month more than the quoted option. Nobody will offer you the bottom row unprompted. You have to ask for a custom term, and most lenders will write one.

What closing costs actually consist of

Refinance costs commonly land between 2% and 5% of the loan amount. They are not one fee but a stack, and some of them are negotiable or shoppable while others are not.

• Lender fees. Origination, underwriting, processing. Negotiable, and the most common place for a competing quote to win.
• Third-party services. Appraisal, credit report, flood certification, title search and title insurance. You can shop title and settlement services; the lender must tell you so.
• Prepaids and escrow. Interest to the end of the month, plus a fresh escrow reserve. Your old escrow balance is refunded, so this is largely a cash-flow event rather than a true cost.
• Recording and transfer taxes. Set by your state and county. Not negotiable by anyone.

Cash-out is a different transaction

A cash-out refinance converts equity into spendable money and increases what you owe. It can be entirely rational, mortgage rates are usually far below card and personal-loan rates, so consolidating expensive debt into a first mortgage genuinely lowers the interest bill. What it also does is convert unsecured debt into debt secured by your house, which changes the consequence of missing payments from a damaged credit file to a foreclosure risk.

Cash-out pricing is worse than rate-and-term pricing, usually by a quarter to three-quarters of a point, and lenders generally cap you at 80% of the home's value. If you are consolidating, run the comparison against a home equity line and against simply attacking the balances directly, because the cheapest headline rate is not always the cheapest total outcome.

Three situations where refinancing wins outright

• Removing mortgage insurance. If your equity has passed 20% through payments or appreciation, a refinance that drops PMI can save $100 to $300 a month even at a similar rate, although asking your current servicer to remove it is free and should be the first attempt.
• Leaving an adjustable-rate loan. Fixing an ARM before it adjusts has value that no break-even calculation captures, because you are buying certainty rather than a saving.
• Shortening the term. Moving from thirty years to twenty or fifteen with a modest rate improvement produces the largest lifetime saving of any refinance, at the cost of a higher payment.