Definition
Refinancing is the process of replacing an existing loan with a new one, typically to obtain better terms such as a lower interest rate, different loan term, or to access equity. Common reasons to refinance include reducing monthly payments, shortening the loan term, converting from an adjustable to fixed rate, or cash-out refinancing to access home equity. However, refinancing comes with closing costs that must be considered.
Formula
The number of months it takes to recover refinancing costs through monthly payment savings.
Example
Mortgage Refinance Example
If you have a $300,000 mortgage at 7% with a $1,996 monthly payment, and you refinance to 5.5% with $6,000 in closing costs, your new payment would be $1,703, saving $293 per month. The break-even point would be about 20 months ($6,000 ÷ $293). If you plan to stay in the home longer than 20 months, refinancing makes financial sense.