How much lower of an interest rate makes it worth refinancing?
Homeowners who can lower their
mortgage rate by 1 percent or more are generally in a great position to
But what if you can only lower
your rate by 0.5 percent — or even 0.25 percent?
The answer might be yes,
especially if you can get the lender to cover your closing costs and still
The ‘right’ amount to lower your mortgage rate is not set in stone. It depends on your refi goals and how much you want to pay upfront to get your rate as low as possible.
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Is it worth refinancing for 1 percent?
Refinancing for a 1 percent
lower rate is often worth it. One percent is a significant rate drop, and will
generate meaningful monthly savings in most cases.
For example, dropping your rate 1
percent — from 3.75% to 2.75% — could save you $250 per month on a $250,000
loan. That’s nearly a 20% reduction in your monthly mortgage payment.
Those monthly savings can be put toward daily living expenses, emergency funds, investments, or paid back into your mortgage to pay the loan off early and save you even more in interest.
Refinancing for a 1
percent lower rate
|Current Interest Rate||3.75%|
|New Interest Rate||2.75% (-1%)|
|Closing Costs||$5,000 (2%)|
|Time to Break Even||20 months (1.6 years)|
|Worth It?||Yes, if you keep the loan ~2 years or longer|
Keep in mind, ‘breaking even’ with your closing costs isn’t the only way to determine if a refinance is worth it.
A homeowner who plans to move or refinance again before the break-even point might opt for a no-closing-cost refinance.
A no-closing-cost refi typically means the lender covers part or all of your closing costs, and you pay a slightly higher interest rate.
Accepting a higher rate will eat
into your monthly savings. But if you can avoid closing costs and still save
month-to-month, there’s no break-even point to worry about.
It’s often a win-win situation
for borrowers who only plan to keep their new loan a few years.
Another option could be rolling the closing costs into your new loan.
This will increase your principal
balance and total interest paid. But if you’re going to keep the loan for more
than a few years, rolling closing costs into the loan amount may be more
affordable than accepting a no-closing-cost loan with a higher interest rate.
“Most borrowers choose the latter— lumping the
closing costs into the loan so they can receive the lowest possible rate. But
that’s not always the best option unless you plan to stay in your home for at
least several years,” says says Tom Furey,
co-founder of Neat Capital.
Is it worth refinancing for 0.5 percent?
There are two common scenarios
where refinancing for 0.5 percent could be worth it:
- If you’ll keep the new loan long enough to recoup closing costs
- OR, if
you can get the lender to cover your closing costs
First, let’s look at a break-even
Remember, the less your rate
drops, the less you save each month. So it takes longer to recoup your closing
costs and start seeing ‘real’ benefits.
For example, dropping
your rate 0.5 percent — from 3.75% to 3.25% — could save you about $150 per
month on a $300,000 home loan.
That’s a decent monthly savings, but it will likely take you over 3 years to break-even with closing costs. So you want to be sure you’ll keep the refinanced loan for at least that long.
Refinancing for 0.5 percent — break-even method
|Current Interest Rate||3.75%|
|New Interest Rate||3.25% (-0.5%)|
|Closing Costs||$6,000 (2%)|
|Time to Break Even||40 months (3.3 years)|
|Worth It?||Yes, if you keep the loan ~4 years or longer|
Now let’s look at how the numbers compare if you can drop your rate
by 0.5 percent using a no-closing-cost refinance.
Say your current mortgage rate is 3.75%. Your refinance lender
offers you a new rate of 2.5%.
Instead of accepting the ultra-low rate, you ask the lender to pay your
closing costs. The lender agrees, and in exchange you accept a higher rate than
the initial offer: 3.25%.
This arrangement only lowers your interest rate by 0.5 percent. But there’s no break-even point because you paid no upfront closing costs. So you start seeing ‘real’ savings right away.
Refinancing for 0.5 percent — no-closing-cost method
|Current Interest rate||3.75%|
|New Interest Rate||3.25% (-0.5%)|
|Time to Break Even||N/A|
|Worth It?||Yes, if you cannot pay closing costs out of pocket|
Of course, you will save a lot more money both month-to-month and in
the long run if you accept the lower mortgage rate and pay closing costs
Those who can easily pay the closing costs out of pocket should
typically do so.
But for homeowners without a lot of savings, it might make sense to accept the higher, no-cost rate. This could allow you to refinance and see month-to-month savings without having to worry about the initial cost barrier.
Is it worth refinancing for just 0.25 percent?
say refinancing isn’t worth it unless you drop your interest rate by at least
0.50 to 1 percent. But that may not be true for everyone.
“Say you are refinancing from an adjustable rate to a 0.25 percent lower fixed rate. Here, refinancing may make sense. That’s especially true if you expect interest rates to increase,” says Bruce Ailion, Realtor and property attorney.
A quarter-point rate drop may
also benefit someone with a large principal borrowed.
“A large loan size may result
in significant monthly savings for a borrower, even when rates dip by only 0.25
percent,” says David
Reischer, attorney and CEO of LegalAdvice.com
To illustrate this point, consider
“Assume you have a $500,000 mortgage at a 4.5% rate. Your monthly principal and interest payment is $2,533, with a PMI payment of $250. So your total monthly payment is $2,783,” says Steven Ho, senior loan officer at Quontic Bank.
But you opt to refinance to a
4.25% rate. This would reduce your monthly payment to $2,459 — a $324 savings
“Over five years, that adds
up to over $19,000 in savings,” Ho notes.
Even if you pay 2 percent in
closing costs on that $500,000 loan, your upfront cost is just $10,000. So you
save almost twice as much as you spent on the refinance within the first 5
Refinancing to consolidate debt
Refinancing for 0.25 percent might also make sense in the case of a debt consolidation refinance.
“Imagine you have $20,000 in
credit card debt. The interest on this credit card is 25%,
which adds up to paying $416 a month just in interest,” Ho says.
Say your original mortgage
balance was $500,000 at a 4.5% fixed rate, equating to a
$2,533 monthly mortgage payment.
But you decide to roll your
$20,000 in credit card debt into your mortgage refi.
You’ll now have a $520,000
mortgage balance and a monthly payment of $2,558 after refinancing to a 4.25% rate.
“Your mortgage payments go up
$28 extra a month. But your overall savings would be $391 a month. That’s
because you’re no longer paying 25% interest on the credit
card debt,” adds Ho.
Refinancing for cash-out and home improvement loans
Say you plan to take cash out during your refinance. Then, the decision to lower your rate by 0.25 percent via a refi gets more complicated.
“With a cash-out refi, your
monthly mortgage payment may not go down,” says Reischer.
“But you can use the cash
taken out to consolidate other higher paying debt obligations. Or it can be
used to make needed home improvements. That can be a very good reason to
do a cash-out refi — to make upgrades that will increase the value of your
Also, think about refinancing
to a shorter term — like from a 30-year to a 15-year fixed-rate mortgage.
“This can yield even lower
refinance rates. And it can result in you paying less in interest payments over
the life of your loan,” says Ailion.
When is it worth it to
How much lower you can get
your interest rate isn’t the only thing you should consider before
The benefits, of course, can
A lower interest rate means
you’ll have smaller monthly mortgage payments. And it often means you’ll save
thousands (maybe tens of thousands) by the time your loan is paid off.
But you have to weigh those
savings against the inherent downsides of refinancing:
- You have to pay closing costs, which are typically 2-5% of the new loan amount
- You restart your loan term from the beginning, usually for another 30 or 15 years
- If your new interest rate isn’t low enough, you might actually pay more interest in the long run because you pay it for a longer time
Plus, most people don’t
actually stay in their homes long enough to pay their mortgages off.
So you should make sure the
savings you calculate are realistic, based on the amount of time you plan to
keep your mortgage.
This is all to say that the
numbers in this article are only examples — use them as guidance, but make sure
your refinance decision is based on your own loan details and financial
“Determining whether the
total costs to refinance makes sense heavily depends on how long you plan to
keep the loan,” says Furey.
“Assume your ultimate
refinance goal is to save money. If so, you’ll want to determine that your
long-term savings exceed the costs to secure the refinance.”
To estimate if a mortgage refinance is worth it for you, try this refinance calculator.
When is refinancing not worth it?
It’s important to remember that
refinancing starts your loan term over. That means you’re spreading the
remaining loan principal and interest over a new 30-year or 15-year
This has big implications for the
long-term cost of your new loan.
Have you had your current mortgage
a long time?
Homeowners who are a decade or
more into their mortgages are less likely to see savings with a small rate
decrease, because they’ll be extending the full payoff period to 40 years or
more — and paying interest on all that ‘extra’ time.
One solution is refinancing into a shorter loan term, like a 20- ,15-, or 10-year mortgage.
Shorter terms typically have
lower rates. And you’ll likely save even more in interest because you pay off
the loan sooner.
But keep in mind: The shorter
your loan term is, the higher your monthly payments will be. So a shorter loan
term is not always an affordable option.
In situations where a homeowner
is nearly done paying off their home loan, a refinance rarely makes sense.
Could refinancing increase your
total interest cost?
If your new rate is not low
enough to generate long-term savings, you could end up paying more interest
over the full loan term.
Take a look at an example:
|Current Mortgage||Refinance Example 1||Refinance Example 2|
|Interest Rate||4%||3.0% (-1%)||3.75% (-0.25%)|
|Total Remaining Interest Cost||$187,900||$158,400||$204,200|
|Long-Term Interest Savings?||N/A||Yes (-$29,500)||No (+$16,300)|
Both these refinance scenarios
save the borrower money month-to-month. But only the first one — where they
drop their rate 1 percent — yields long term savings.
The second refinance option —
dropping the rate by 0.5 percent — actually costs this borrower $16,000 more
if they keep their loan its full term.
Of course, most homeowners do not
keep their mortgage its full term. This changes the math. Someone who’s only
going to keep their refinanced loan for 5 years, for instance, will not pay
nearly as much ‘extra’ interest as someone keeping it the full 30.
The right decision also depends
on your reason for refinancing.
For example, the second refinance
option might make sense if the homeowner has had an income reduction and needs
to lower their mortgage payments to be able to afford them. Maybe one spouse or
partner became a stay-at-home parent or their job was eliminated during an
If they can get a no-cost refi and a 0.5 percent rate reduction, they might be happy with the $100 monthly savings on their new loan — despite a higher long-term cost.
Today’s refinance rates
The bottom line? It’s a good
time to refinance when your savings are greater than the cost.
“If refinance rates are
declining, it may pay to wait to maximize the difference between your current
rate and the new rate,” Ailion adds.
“But when lower refinance
rates begin to rise, it’s probably a good idea to pull the trigger.”
Today’s mortgage rates are still
ultra-low, but they may not be around forever. It’s a good time to consider
locking in a low refinance rate to maximize your savings.