Mortgage Refinance: Tradeoff Between Rate and Closing Cost

Say you chose a lender for your mortgage refinance. You still have to decide whether you should go for a lower rate with a higher closing cost or a higher rate but with no or minimal closing cost.  You can also buy down the rate by paying points.

Making the perfect decision requires a crystal ball. Will the mortgage rate go down in the future? When and by how much? How long are you going to keep this loan? Note I didn’t ask how long you are going to stay in the house, because you can still stay in the house and refinance the loan again if the rate goes down.

The good thing is we have some calculators to help us make this decision. I will use a hypothetical loan as an example. Say I want a $200,000 loan in Missouri with a 30-year fixed rate, I see these choices from a lender’s website:

Rate Total Closing Cost
4.500% $0
4.375% $1,269
4.250% $2,669
4.125% $4,241

Kalotay Calculator

First I use the Andrew Kalotay Associates’ Optimum Mortgage Refinancing Calculator. I wrote about this calculator in a previous post. I like this calculator because it takes into consideration the possibility to refinance again if rates go down in the future.

I enter the no closing cost loan as my current mortgage. This is very important. Forget about the real current mortgage if it has a higher rate. I know at a minimum I can refinance to 4.5% with no cost. Therefore the no cost loan is my baseline.

Then I enter 4.375% with $1,269 closing cost as my proposed new mortgage. The calculator tells me “Not Yet!” which means I shouldn’t pay $1,269 to take the rate down from 4.5% to 4.375%. The calculator also says Not Yet for the other two scenarios.

Neat, huh?

Mortgage Professor Calculator

To double check the calculation, I use Mortgage Professor’s Calculator 3a for refinancing one fixed rate loan to another fixed rate loan. Once again, I enter the no cost loan as my current loan.

Mortgage Professor’s calculator asks more questions. I provide some reasonable answers. For my three alternatives to the no cost loan, it tells me:

Rate Total
Closing Cost
over 10 years
4.375% $1,269 $431 7 years 6 months
4.250% $2,669 $703 7 years 11 months
4.125% $4,241 $770 8 years 6 months

Paying a higher closing cost will give me some savings over 10 years, although the amount saved is really small. The breakeven period, i.e. the time I have to keep the loan in order to benefit from the refinance is really long.

For my hypothetical example, both calculators tell me it’s really not worth it to pay the closing cost for a slightly lower rate. When it’s time to evaluate your tradeoff between rate and closing cost, try these two calculators.

This is part of a “How to Refinance” series of posts. Other posts in the series include:

Refinance Your Mortgage

Mortgage rates hit new lows. I saw rates as low as 3.25% for 30-year fixed, 2.625% for 15-year fixed, with no points and low closing cost. Check mortgage rates in your state.


  1. Sammy_M says

    Great application of the Optimum Mortgage Refinancing Calculator! I was looking at the 30 year @ 4.25 with a $950 credit toward closing or a 4.375 with $3500 credit. I ran it through the calculator, and it said “Not Yet!” Helped confirm what I was thinking. Going with the 4.375.

  2. roadman says

    Sammy_M should use the mortgage points calculator at the Kalotay site instead.
    Just because trading the 4.375 for a 4.25 with an effective cost of $2450 wouldn’t have been an efficient exercise of that option on september 16th doesn’t mean it was not a better option-adjusted rate to exercise into from his existing loan.

    Also, people should realize that these public calculators have limitations.
    Notably, the value of the option is calculated using market conditions current at the time of use (and using an undisclosed measure of volatility). Clicking on the “fixed income quants only” links take one to versions in which non-current treasury yields can be plugged in, or a volatility index varied, but even general inferences to be drawn through tweaking these parameters seem weak, and suspect – to this non-quant anyway.

    Mainly though, the current-condition-specific aspect devalues the use of these calculafors to revisit old decisions or to anticipate ones to be considered for execution in the murky future. It’ll have to remain a conjecture that I might have chosen differently in a recent refi had I known about them two months ago; as regards the future: apart from not being what it used to be, it’s murky.

  3. Jim Thurman says

    Isn’t it rather less than honest to casually toss the ‘no cost’ slogan around? -especially in todays mortgage environment??
    Those people who use the ‘no cost’ hook to pull prospects in are in my opinion very irresponsible. If a Borrower ‘assumes’ they have ‘no costs’ involved in getting their new mortgage I am certain that they’ve been misled right on past the door that says ‘wrapped into your higher interest rate!’

  4. Harry Sit says

    Maggie – I usually get quotes from these three lenders: First Internet Bank of Indiana (, call 800 number for no-cost quotes), National Mortgage Alliance (click on the “true no-cost refi” banner ad on top right, refresh browser if you don’t see it) , and Amerisave.

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