To do a realistic, cost-conscious mortgage refinance, first determine your break-even point, or how long it will take to start gaining a positive return on your investment of the costs of refinancing. With a calendar and a calculator-or help from your number-crunching lender-it's relatively easy.

Maybe in a perfect world, you'd be able to refinance to a lower interest rate for free. In the real world, however, you have to pay for it, and it usually costs a rather significant amount of money. Many homeowners overlook this important fact as they rush to capture alluring cheaper rates. In so doing, they risk undermining and negating their potential savings. Even worse, many borrowers refinance in such a way that they actually lose money in the process, even though they think that they're saving. To avoid this trap, sit down with your lender first, itemize your costs, and determine your break-even point.

Recouping your costs

For a refinance mortgage to make good financial sense, you need to remain in your house long enough to begin reaping the net rewards. Add up all the various charges, including lender's fees, appraisals, credit checks, and legal fees. (Keep in mind that you wouldn't be paying any of these if you don't refinance.) Once you know the grand total of your refinance costs, you'll know how much you need to recoup to start realizing the benefits. Before you can be paid back for your refinance, you first have to pay yourself back for all those charges. The more it costs to obtain the new loan, the longer the break-even period will be.

Say, for example, that your current monthly payment is $1,500. If you can refinance to a new monthly payment of only $1,400, you'll capture monthly savings of $100. But if the total fees required to refinance add up to $2,400, it will take you two years to recoup those fees ($100 X 24 months = $2,400). Once that 24-month period passes, you'll be realizing approximate net savings of $100 per month, or $1,200 per year. That adds up to about $12,000 or more over the next decade.

Rate of mortgage pay-off

One factor that's often excluded from calculations is the rate at which you're paying off your loan. If you refinance from a 30-year loan into a 15-year mortgage, you should add credit for paying off your loan in half the time. Even if your monthly payments after refinancing are the same or higher, it might still be the most cost-effective option, because you'll have no monthly payments whatsoever after only 15 years. If the loan that you're refinancing out of still has 25 years to pay on it, you're essentially saving yourself 10 full years of interest payments. Those savings need to be included in your formula.