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 vary by transaction. Separate true transaction costs from prepaid interest, escrow deposits, refundable balances and down payments. Upfront cash divided by the payment reduction is only a simple cash-flow measure; financed fees, term extensions and remaining debt can change the economic result.
The 1% rule — and why it's outdated
A rate-change threshold is only a heuristic. Compare transaction costs, interest and remaining debt at the same expected holding date, including any term extension or financed charges. Neither a 0.5 nor 1 percentage-point drop guarantees savings.
Other reasons to refinance besides rate
- Mortgage insurance: A new conventional loan may avoid borrower-paid PMI at 80% LTV or below, subject to its program and valuation. Check whether the existing PMI can be removed without refinancing.
- Term: A shorter new term can change payments and interest. Use actual balances, rates and costs; a 15-year term does not universally increase payment or guarantee lower holding-period cost.
- ARM to fixed: A fixed rate can remove contractual rate-reset uncertainty for that loan, subject to its terms. Escrow, insurance and other housing costs can still change, and refinance costs must be compared.
- Cash-out: Access your equity for renovations, debt consolidation, or other needs.
A new loan has its own amortization based on its actual balance, rate and term. Extending the remaining term can lower payments while increasing interest or debt at the end of your holding period. A lower payment alone does not establish a lower cost.