How to Calculate If Refinancing Is Worth It

What is refinancing

Refinancing involves taking out a new loan to pay off an existing mortgage, replacing the original loan with a new one that may have more favorable terms. This process typically requires lender approval and involves application and closing steps, similar to your original mortgage.

The main goal of refinancing is often to lower your interest rate, reduce monthly payments, or change the loan term. By securing a lower rate, you can reduce both your monthly payment and the total interest paid over the life of the loan.

• Rate-and-term refinance: change your interest rate and/or loan term without accessing your home's equity.
• Cash-out refinance: borrow more than you owe and receive the difference in cash, which can be used for renovations or other purposes, but increases your loan balance and may extend your payoff timeline.
• Adjustable-rate mortgage (ARM) to fixed-rate: switch from a variable rate to a fixed rate, making payments more predictable.

Sources: Fannie Mae

Gathering Data: Current Loan Terms and New Offer

Before you can evaluate refinancing, you need precise details about your current mortgage and the refinance offer you are considering. Using a loan refinance calculator can help, but the key inputs are the same regardless of the tool.

Key inputs include your current mortgage balance, current interest rate, the new loan term, the new interest rate, and the total closing costs associated with the refinance.

Closing costs typically range from 2% to 5% of the new loan amount and can include origination fees, settlement and title fees, third-party fees, and taxes and government fees.

• Current mortgage balance
• Current interest rate
• New loan term (e.g., 30-year or 15-year)
• New interest rate
• Total closing costs

Sources: Fannie Mae

Inputs for Calculating the New Monthly Payment and Total Cost

To estimate a new monthly payment, you will need your remaining loan balance, the new interest rate, and the new loan term. These three inputs determine the payment amount, but the exact calculation depends on the loan's amortization schedule.

Keep in mind that if you refinance to a shorter term, your monthly payments may be higher, but you build equity faster and reduce total interest paid.

Lenders may advertise no upfront fees, but that usually means rolling the fees into the loan balance. In that case, you will pay for those fees over time along with interest, increasing the total cost.

Sources: Fannie Mae

Break-Even Point: Recovering Your Refinancing Costs

The break-even point is the time it takes to recover the money you spend on refinancing costs through the monthly savings you achieve. In other words, it is how long you need to stay in your home for the savings to offset the costs.

To evaluate whether refinancing makes sense, consider the break-even point alongside how long you plan to stay in your home. If you move before that time, the savings may not outweigh the costs.

A shorter break-even period is generally better, as it means you recover costs sooner.

• Compare your monthly savings to your total closing costs.
• Estimate how many months it will take for those savings to cover the costs.
• Review your expected time in the home to see if you will reach that point.

Sources: Fannie Mae

Comparing Current Loan vs. Refinanced Loan

To decide if refinancing is worthwhile, compare the total cost of your current loan (remaining payments and interest) with the total cost of the new loan (including closing costs and interest).

A mortgage refinance calculator can display your new total monthly payment and potential monthly and annual savings. Use those figures to see how long it will take to recover the money invested in refinancing costs.

Remember that a lower interest rate can reduce both monthly payments and total interest paid. But if you extend your loan term, you may end up paying more interest overall despite lower monthly payments.

• Calculate remaining payments on your current loan.
• Calculate total payments on the new loan, including interest and fees.
• Compare the savings over your expected time in the home.

Sources: Fannie Mae

Factors to Consider: Closing Costs, Rate Changes, and Term Changes

Closing costs are a one-time expense that directly affects your break-even point. They are typically 2% to 5% of the new loan amount, so it's crucial to know the exact fees upfront.

A lower interest rate is the most common reason to refinance, but rate changes can also come with longer or shorter terms. A shorter term, like going from 30 years to 15 years, may mean higher monthly payments but faster equity building and less total interest.

Refinancing from an adjustable-rate mortgage to a fixed-rate mortgage can provide financial stability, but it may not always lower your rate. Weigh the benefits of predictable payments against any changes in your monthly cost.

Sources: Fannie Mae

How to Use a Refinance Calculator Effectively

A refinance calculator is a valuable tool, but its output depends on the accuracy of the inputs you provide. Start with your current loan balance and current interest rate, then enter the new rate and term you are offered.

Include all closing costs, not just the lender’s origination fee. If you are rolling costs into the loan, the calculator will account for that in the monthly payment.

This calculation guide will show your new total monthly payment and potential monthly savings. To understand your break-even point, compare the total closing costs to the monthly savings, but remember that calculators are estimates; actual costs may vary based on your lender, location, and credit profile.

Sources: Fannie Mae