How to Calculate Your Refinancing Break-Even Point
Figuring out your break-even point is straightforward. You only need two numbers: your total closing costs and your monthly savings.
The formula is:
Break-Even Point (in Months) = Total Refinance Closing Costs / Monthly Savings
Let’s use a practical example:
- Old monthly mortgage payment: $1,800
- New monthly mortgage payment: $1,600
- Total refinance closing costs: $4,000
Step 1: Find your monthly savings.
$1,800 (Old Payment) – $1,600 (New Payment) = $200 (Monthly Savings)
Step 2: Apply the formula.
$4,000 (Closing Costs) / $200 (Monthly Savings) = 20 Months
In this scenario, it would take 20 months (one year and eight months) to recover the costs of refinancing. After this point, the $200 saved each month is a direct benefit to your budget.
Factors That Affect Your Break-Even Point
Several variables can change how long it takes to break even:
- Closing Costs: Higher closing costs directly lead to a longer break-even period. These fees include loan origination, appraisal, title insurance, and more. While some lenders advertise “no-closing-cost” refinances, these often hide the expense in a higher interest rate.
- Interest Rate Difference: A larger reduction in your interest rate means greater monthly savings and a faster break-even point. A minor rate drop may not be enough to justify the upfront costs.
- Loan Term: Refinancing into a shorter loan term (like from 30 to 15 years) might increase your monthly payment, even with a lower rate. This would eliminate the monthly savings used in the break-even calculation.
When to Consider Refinancing Beyond the Break-Even Point
While the break-even calculation is key, other goals can also make refinancing a smart move:
- Accessing Home Equity: A cash-out refinance allows you to borrow against your home’s equity, providing funds for renovations, education, or other large expenses.
- Switching Loan Types: You might want to move from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage to gain payment stability. This predictability can be worth the refinancing costs.
- Consolidating Debt: If you have high-interest debt from credit cards or personal loans, you can roll it into your mortgage. A debt consolidation refinance can simplify your finances and lower your overall interest payments.
Common Mistakes to Avoid
Be mindful of these errors when considering a refinance:
- Underestimating Costs: Make sure you account for all closing costs listed on the Loan Estimate provided by your lender, not just the most obvious fees.
- Ignoring Your Timeline: If you plan to sell your home before reaching the break-even point, you will lose money on the transaction. Be realistic about how long you intend to stay in the property.
- Overlooking the Total Interest: A lower monthly payment is appealing, but if you extend your loan term, you might pay more in total interest over the life of the new loan.
Frequently Asked Questions (FAQ)
What is a good break-even point?
A “good” break-even point is subjective, but many financial advisors suggest aiming for a period of 24 to 36 months or less. The ideal timeframe depends entirely on how long you plan to remain in your home. If your break-even point is five years but you plan to move in three, refinancing is likely not a good financial decision.
Do “no closing cost” refinances have a break-even point?
Yes, though it’s less direct. With a “no closing cost” refinance, the lender typically covers the upfront fees in exchange for charging a higher interest rate. While you don’t pay cash at closing, your break-even point is the time it takes for the savings from a traditional refinance (with a lower rate) to surpass the extra interest you’re paying on the “no-cost” option.
External Authoritative Source:
The Consumer Financial Protection Bureau (CFPB) provides a comprehensive guide on comparing mortgage refinance offers to help you make an informed choice.
