Rate-and-term refinance: when it pays, how to compute the break-even

The old rule — refinance when rates drop a full point — is too crude. The right rule is a break-even calculation that accounts for closing costs, how long you will stay, and how far into your current loan you are.

What it is

A rate-and-term (or “no cash-out”) refinance replaces your mortgage with a new one for roughly the same balance, to lower the rate, shorten or lengthen the term, switch from an ARM to a fixed rate, or drop FHA mortgage insurance by moving to conventional. You may roll closing costs into the loan and receive up to a small amount of cash (conventional allows the lesser of 2% or $2,000) without it being classified as cash-out.

The break-even

Total closing costs ÷ monthly savings = months to break even. Refinancing a $320,000 balance from 7.25% to 6.25% saves about $210 a month; with $7,000 in costs, the break-even is about 33 months. If you will keep the home and the loan longer than that, it pays. Compare the new payment with what your old loan would have cost over the same period, not with the original payment.

The clock problem

Refinancing a loan that is eight years into a 30-year term with a new 30-year loan restarts amortization: the payment falls partly because you are stretching the remaining balance over 30 years again. To compare fairly, ask for a 22-year term (many lenders offer custom terms) or pay the new loan on the old schedule. A 15- or 20-year refinance often costs little more per month than the old 30-year payment and saves enormous interest.

Streamline options

FHA Streamline: no appraisal, limited income verification, reduced upfront MIP, if you already have an FHA loan and the refinance produces a “net tangible benefit.”
VA IRRRL: no appraisal, no income verification, reduced funding fee (0.5%), for existing VA loans.
USDA Streamlined-Assist: no appraisal or credit review for existing USDA loans with 12 months of on-time payments.
Fannie Mae RefiNow / Freddie Mac Refi Possible: for borrowers at or below 100% of area median income, with an appraisal credit and relaxed DTI.

When not to

If you may move within the break-even period, if the new loan would extend your payoff past retirement without a plan, if the costs are being recovered with a higher rate than advertised (“no-cost” loans are never free), or if you would lose a feature — an assumable FHA or VA loan, for instance — that has value in a higher-rate future.

Frequently asked questions

Does refinancing hurt my credit?

A hard inquiry and a new account cause a small, temporary dip; closing the old loan does not erase its history.

Can I refinance with the same lender faster?

Sometimes the servicer offers a streamlined “retention” refinance with reduced costs. Still compare with two outside quotes — retention offers are often not the best available.

How soon after buying can I refinance?

Conventional rate-and-term: generally no waiting period, though some lenders impose six months. FHA Streamline: 210 days and six payments. VA IRRRL: 210 days and six payments.