When is refinancing worth it, and how much lower does my rate need to be?

Is there a rule for how much my rate should drop?

You'll hear "refinance when rates drop 1%." It's a rough guide at best. A half-point drop can be worth it on a big loan, and a full point can be a waste on a small one you'll pay off soon. What actually matters is your break-even.

How do I figure my break-even?

Closing costs ÷ monthly savings = months to break even.

• $5,000 in costs ÷ $200 a month in savings = 25 months.
• If you'll keep the loan longer than that, you come out ahead. If you might sell sooner, you probably won't.

Should you pay the costs in cash or roll them into the loan? Rolling them in keeps cash in your pocket but adds to your balance and the interest you pay on it. I'll show you both.

What else should I weigh besides the rate?

• Your term: going from 25 years left back to 30 lowers the payment but can raise your total interest. Refinancing into a 20- or 25-year loan can give you a lower rate without resetting the clock.
• Mortgage insurance: dropping FHA mortgage insurance or PMI can be worth more than the rate itself.
• Adjustable to fixed: locking in a fixed rate before an adjustment can be worth it even with a small rate change.
• Your plans: moving, retiring, or paying the house off early all change the answer.

Example scenario (illustrative)

A homeowner in San Diego owes $480,000 with 27 years left. A refinance would cost about $6,500 and save roughly $260 a month. Break-even is 25 months, and they plan to stay at least 10 years. We also price a 25-year term so they don't add years to their loan, and they choose the option with the lowest total cost.

Our take

A refinance should pay for itself, period. I'll give you the break-even month and the total-cost comparison in writing. If it doesn't work yet, I'll tell you, and I'll call you when it does.