Refinance Break-Even: When the New Loan Pays for Itself: the facts

1. The common rule divides the closing costs by the drop in the monthly payment and calls the answer the break-even. It is quick, and it is wrong whenever the new loan's term is not the old loan's remaining term, because a longer term lowers the payment by stretching the principal out, not only by cutting the rate.
2. The truer count is what each loan costs over time: the payments made plus the balance still owed. For any loan that is the original balance plus the interest paid so far, so the new loan is ahead only once the interest it has saved exceeds the closing costs, whether those were paid in cash or added to the balance.
3. Example: $400,000 at 7.0% with 27 years left, refinanced at 6.0% for the same 27 years with $8,000 in costs. The payment falls from $2,751.26 to $2,495.94, the simple rule says 32 months, and the interest count says 24 months. Keeping the home 7 years, the new loan leaves you ahead by about $19,926.
4. The same refinance into a fresh 30 years cuts the payment further, to $2,398.20, and the simple rule improves to 23 months. But the interest over the life of the new loan is $463,353 against $408,685 for the matched term, and the lifetime saving shrinks from about $74,723 to about $20,055. The lower payment is partly the clock being reset.
5. A half-point drop into a fresh 30 years with 20 years left can never pay for itself on interest: $250,000 at 6.5% refinanced at 6.0% with $5,000 in costs has a simple break-even of 14 months, yet the interest saved never catches the costs, and the lifetime interest is about $97,252 higher. The lower payment is a longer loan, not a cheaper one.
6. The break-even answers one question: when the new loan has paid for its costs. The verdict depends on a second one: how long you will keep the home. A refinance that pays for itself in two years and is sold in one was a loss, and one that never breaks even on interest can still be the right choice for a household that needs the lower payment.

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