A lower rate doesn't automatically mean you should refinance. The question is whether the savings outweigh the cost — and how long it takes to break even.
The break-even calculation
Refinancing costs money — typically 2-5% of the loan in closing costs. To know if it's worth it, calculate how long it takes for the monthly savings to recoup those costs.
The 1% rule — and why it's outdated
You've probably heard "only refinance if rates drop at least 1%." That's a rough heuristic, not a rule. What actually matters is your break-even timeline vs. how long you plan to stay. A 0.5% drop on a large loan might be worth it. A 1% drop when you're moving in 18 months might not be.
Other reasons to refinance besides rate
- Remove PMI: If your home has appreciated and you now have 20%+ equity, refinancing into a new conventional loan eliminates PMI.
- Shorten the term: Refinancing from a 30-year to a 15-year loan at a lower rate can save massive interest, though your payment goes up.
- Switch from ARM to fixed: If you have an adjustable rate and rates are rising, locking into a fixed rate eliminates future uncertainty.
- Cash-out: Access your equity for renovations, debt consolidation, or other needs.
Refinancing resets your amortization — meaning you start paying mostly interest again. Factor that into your calculation if you've been paying your current loan for many years.