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Short Summary
Main recommendation: Refinance a mortgage to a shorter term only when the interest savings from a lower rate pay back the closing costs within about three years and you plan to stay in the home that long; do not refinance just to shorten the term when your current rate is low. The break-even period is calculated by dividing total refinancing costs by the annual interest savings. In the example, a roughly 1.5-point rate spread (rounded from the actual 1.875-point difference) on a $358,000 balance saves about $4,600–$5,000 a year, against $4,000 to $5,000 in closing costs, for a break-even of about one year.
Key Points
- Only the interest savings from the rate change count as the real savings; the extra payment toward principal is not an expense saved, it is equity built.
- Closing costs and any cash brought to the table to reach an 80% loan-to-value ratio should be compared against interest savings to find the break-even point.
- A common rule of thumb is that break-even should be under three years, since life changes or a sale can interrupt the plan; the speaker cites an average of 5.6 years that a mortgage stays on the books in America due to refinances and resales.
- Refinancing a very low rate, such as 3%, to a 15-year term is generally not worthwhile because the interest savings are too small to recover costs.
- Instead of refinancing a low-rate 30-year loan, the host suggests calculating the difference between the 15-year and 30-year payments and paying that difference as extra principal, which pays off the loan in about 15 years.
- Check both the contract rate and the APR when comparing lenders, since fees are built into the APR and the contract rate alone can hide costs.
Details Worth Noting
- Concrete instructions:
- Find your current interest rate and the new rate offered.
- Subtract the new rate from the current rate to get the rate spread (example: 3.75% minus 2.125% is about 1.6 points, rounded in the call to 1.5 points).
- Multiply the spread (in percent) by your loan balance to estimate annual interest savings (example: each 1% on a $358,000 balance is about $3,500 a year).
- Add all refinancing costs, including closing costs and any extra cash needed to reach 80% loan-to-value.
- Divide total refinancing costs by annual interest savings to get the break-even period in years.
- Refinance only if the break-even is under about three years and you expect to keep the house at least that long.
- If you have a very low rate, such as 3% on a 30-year loan, do not refinance for term alone; instead, compute the 15-year payment minus your 30-year payment and pay that amount as extra monthly principal.
- When shopping lenders, ask for both the contract rate and the APR and compare them.
- For future purchases, the host recommends starting with a 15-year fixed mortgage rather than refinancing later, if not paying cash.
- The example in the call: a 3.75% current rate versus 2.125% on a 15-year refinance, with a $358,000 balance and $4,000 to $5,000 in closing costs, gives a break-even of about one year if the homeowner stays 18 months.
- The host notes that the payment change from a 30-year to a 15-year term is mostly a principal change, not a savings, so it should not be counted as a saving in the break-even math.
- The host says the refinance is a smart move overall given the break-even is under a year, while noting the caller seems undecided about future plans.
Bottom Line
A refinance to a shorter term is worth it mainly when the rate drop is large enough to recover closing costs quickly, and the decision should rest on the break-even calculation rather than the payment or term alone.
