If buying a home is the most important financial decision you'll ever make, deciding whether or not to refinance your mortgage for a lower rate is the second most important. The amortization calculator below will help you determine whether or not it makes sense to refinance, and how long it will take you to break even based on your new monthly payment.
Does it make sense to refinance?
Refinancing your home only makes sense when you will recoup the costs of refinancing in a relatively short period of time. Although many banks advertise "no-cost" or "fee-free" refinancing offers, the truth is that refinancing is never free. Frequently, costs are simply added to the loan balance, or made up for in the form of higher rates of interest above other mortgages with upfront costs.
Some costs are simply unavoidable. Title insurance, any attorney's fees, and other closing costs like flood certificates and documentation fees can add up fast. Additionally, appraisal fees and taxes can add further to the cost of refinancing.
But don't take this to mean that refinancing is a bad deal, or that you won't save money. Refinancing a mortgage at a rate only 0.50% lower than your current rate can potentially save you thousands of dollars in interest payments over the life of the loan. Many longtime homeowners have refinanced their homes numerous times, saving money by refinancing over a period of generally declining interest rates.
It's not just about the monthly payment
The actual process of refinancing is not all that different from getting a mortgage to purchase a home. When you refinance a mortgage, you are taking out a new mortgage, presumably at a lower rate, to pay off an existing mortgage at a higher rate.
Unfortunately, mortgages only come in a handful of amortization periods. The most common are 15-year and 30-year mortgages. Some banks advertise 10-year and 20-year mortgages. But none advertise, say, a 23-year mortgage for people who want to refinance a 30-year mortgage they have had for 7 years.
This can make it difficult to compare mortgages on an apples-to-apples basis. After all, you can almost always reduce your monthly payments by refinancing a mortgage that will be paid off in 10 years by extending it to 30 years. What really matters is whether or not you can save money by refinancing and pay off your home on the original schedule.
A calculator for making an informed decision
The calculator below will help you make an informed decision based on a true apples-to-apples comparison. It will even calculate the monthly payments you need to make so that you pay off your refinanced mortgage on the same timeline as your current mortgage.
Thus, if you have 25 years remaining on your current mortgage, and intend to refinance it into a 30-year mortgage, it will tell you how much you need to pay each month to pay off the new mortgage on the same 25-year timeline.
The most important set of data is labeled "enhanced refinance." This tells you how long it will take you to pay off your mortgage if you refinance, how much you should pay each month to pay it off in the same length of time as your existing mortgage, and the breakeven point, or how long it will take before you start saving money because you refinanced. The enhanced refinance scenario is the true "apples-to-apples" comparison discussed above.
Don't have a mortgage quote in hand? That's OK -- we can roughly estimate how much it might cost you to refinance.
Estimating the cost of insurance and closing costs
Refinancing can be expensive, and fees add up. Expect to pay fees in many different forms, from appraisal fees, to documentation and application fees. A June 2016 survey of 10 lenders in every state by Bankrate found that these expenses ranged from $1,837 to $2,655 on a $200,000 mortgage. For the sake of simplicity, we'll call it 0.9% to 1.3% of the loan amount.
But this figure notably excludes a couple particularly expensive costs of refinancing, the largest of which are title insurance and title search. Expect a title search and title insurance to add another 1% to 1.5% of the mortgage amount to your closing costs. (You may be able to get a lower price on title insurance for asking for a "reissue rate" if your existing mortgage was issued in the last 10 years.)
All in all, you can expect to pay about 2% to 2.8% of the amount borrowed in closing costs. Simply multiply the amount you owe on your existing mortgage by 2% or 2.8% and enter it in the calculator above as "other fees" and you'll be well on your way to finding out if refinancing is right for you.
Keep in mind that these are rough estimates of the actual costs, which will vary by lender, location, and insurance company. But if the math makes sense with these estimates, it's probably time you seek out a mortgage quote to take the first step toward refinancing your home, anyway.
Should you refinance your home?
If the breakeven point under the "enhanced refinance" scenario is less than three or four years, it may make sense to refinance your loan for a lower interest rate. This is especially true when you intend to refinance a fixed-rate mortgage into a new, fixed-rate mortgage.
If you want to refinance an adjustable-rate mortgage into a fixed-rate mortgage for the simple reason of peace of mind should interest rates rise, then how much you save by refinancing may be less relevant. Understandably, many people would prefer know what their payment will be for the next 15 or 30 years, rather than taking a gamble on where interest rates move in the future.
But in any scenario, refinancing makes most sense if you expect to live in your current home for a very long time. The truth is that the average American will move about nine times after reaching 18 years of age. How that is split between homeowners and renters isn't exactly certain -- logic follows that people who rent probably move more often -- but the average American moves very frequently.
Moving, unfortunately, negates any future benefit of refinancing. You'll have to repay the mortgage on your existing home in full when you move, and take out a new mortgage at the current market rate to buy another.