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I got an e-mail from the company that brokered our mortgage loan offering me a great opportunity to refinance at a lower rate and save almost $200/month. Seeing as the rate drop was only 0.25% I was curious as to how so much money could be saved, as presumably they would be making some money on the refi as well. Running the numbers they gave me revealed that the exact amount to the penny that they quoted as the new monthly payment was for a 30 year mortgage at the quoted interest rate. But I have already been making payments on a 30 year mortgage for a few years now and don't have any interest in extending my mortgage out by the number of months I have already paid.

When I ran the quoted rate for the lower number of months remaining on the mortgage, it still showed a monthly savings, but much less, slightly under $50. While this is a much worse deal it still appears to save money, assuming that they have rolled all their costs hidden into the loan somehow. If this case, is it still "worth" it? And if so, how little savings justifies refinancing? $40/month? $20/month? $1/month? It seems at some point it gets silly, but I don't know how to quantify what hidden costs besides money would be used to determine this, how much time it takes to deal with paperwork, affects on credit ratings and other intangible effects which may be hard to pin down and any other unknowns I don't know.

Is there some rule of thumb for how much per month in savings justifies a refi?

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When evaluating a potential refinance for the purpose of reducing the interest rate, you need to calculate the payback time. Refinancing costs money in closing costs, so there is some point in time in the future where the money you have saved in interest equals the amount of money you have spent on the refi closing costs.

As you noticed, looking at the difference in monthly payment compared to what you are paying now doesn't tell the whole story, because when you refinance you often reset the amortization calendar (another 30 years, for example). What you want to look at is the amount of interest being spent every month.

For example, let's say that you have $100,000 of principal left to pay on your mortgage, and you currently have a 4.0% rate. Now consider a refinance offer of 3.75% with closing costs of $1,000. At your current 4.0% rate, your mortgage is costing you approximately $333 in interest charges per month. (The mortgage charge goes down a little each month as you pay down principal.) At 3.75%, the interest charge is only about $312 per month, saving you $21. It would take nearly four years to reach the payback point to justify the $1,000 closing costs. If you are sure that you won't be selling the house before then, you might decide this is worth it, but most would probably not spend that amount of money on closing costs to save this little in interest.

In my analysis, I didn't even take into consideration the fact that the mortgage calendar might be reset to 30 years, even though you are already part way through the 30 years on your current mortgage. Here is the reason: When you refinance, if the mortgage calendar gets reset to another 30 years, the monthly payment will be less than what you had before, being based on a smaller principal amount. However, if you continue to pay your old monthly payment (paying more than what is required), you will pay off the mortgage in the same amount of time than you would have without the refi. (Actually a little earlier, because of the smaller interest charges.)

If you are looking for a rule of thumb, the one I have heard before is that a difference in interest rate of one whole percentage point or more is what you want to look for when refinancing. But it really depends also on the closing costs, as well as how long you plan on staying in the house.

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  • No mention was made of any closing costs in the e-mail - I had just assumed they were taking a bit of spread on the interest rate or something.
    – Michael
    May 7 '20 at 1:24
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    If there are literally zero closing costs, 1/8% (assuming that's the lowest increment) can make it worth it, time is the only cost. If there are costs, then one has to do the math, as you showed. Of course. May 7 '20 at 1:31
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    @Michael Sometimes the closing costs are simply rolled into the new mortgage, which means that you are still paying for them, and they need to be considered. Other times the bank will pay all the closing costs themselves (zero-closing cost refinance) in exchange for a higher interest rate. In that case, there is no payback time, but of course, you probably aren't getting the best interest rate you could be getting. May 7 '20 at 2:35
  • @Michael their ad is misleading, they are trying to get a call back so they can talk you into a bad deal. Use this answer as your guide.
    – Pete B.
    May 7 '20 at 13:44
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No, and I think you should ignore "savings per month", which really is just the difference between the minimum monthly payments. What you need to look at is what you save overall, across the life of the mortgage, and compare it to the cost of refinancing.

A couple examples (using Google's mortgage calculator):

Assumption: You have a $100,000, 30-year mortgage at 3.5%. Your monthly payment is $449. The total cost of the mortgage ends up being $161,656, meaning you will have paid $61,656 in interest by the time it is paid off in 30 years.

Lower monthly payment: If you refinance and keep the $100,000 balance and 3.5% rate, but get a 40-year term, your monthly payment is only $387 (monthly savings of $62), but you end up paying $185,948 over the life of the loan (loss of $24,292!). The bank would need to pay you $25k in closing costs for this to be worth it for you.

Higher monthly payment: If you refinance and keep the $100,000 balance and 3.5% rate, but get a 20-year term, your minimum monthly payment goes up to $580 (an increase of $131), but your total cost decreases to $139,190, saving you $22,466 over the life of the loan. This would certainly be many times more than the cost of refinancing.


These are just some very simplified examples to show the math. They leave out a couple things:

  • For example, it wouldn't make sense to pay to refinance in the second case, since you get the same interest rate; you could just pay the extra on your current loan to realize the savings, without being obligated to pay the higher amount each month (although some lenders/contracts may have a prepayment penalty - you'd have to factor that in).
  • It also may make sense to refinance to a lower payment with higher total cost if the interest rate is low enough that you think can make more money investing elsewhere.
  • If you plan to move any time in the future, you need to compare the savings between now and when you move, not when the term of the mortgage ends. A lower rate may save you tens of thousands of dollars by the end of the 10/15/20/30 year loan, but only save you tens of dollars in the first year. If you expect to move/sell before these savings make up for the closing costs, it's not worth it.
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    This is a good analysis. I think the one thing missing is that IF one has the personal discipline, refinancing AND then continuing to make the previous payments is a nice way to go. This is what I've done... yes the re-fi also spreads the payments back out, but if you continue to make your previous payments, you dig into that principle pretty quick and pay the new loan of years earlier and cheaper than the original loan. BUT you must have the discipline to do that; a lot of people don't. May 7 '20 at 14:45

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