Calculating Break Even on Refinance

What is Break Even in Refinancing?

The break-even point in refinancing refers to the time period after which the savings from the new loan or mortgage outweigh the costs of refinancing. These costs typically include closing costs, points, and any fees associated with obtaining the new loan.

Understanding the break-even point helps you determine whether refinancing is financially beneficial in the short term or if you should wait until interest rates are more favorable or your financial situation improves.

How to Calculate Break Even

Calculating the break-even point for refinancing involves several key factors:

1. Original loan details: Current interest rate, remaining balance, and monthly payment.
2. New loan details: Proposed interest rate, closing costs, and any points paid.
3. Time period: The number of months or years you plan to keep the new loan.

The formula to calculate the break-even point is:

Where Monthly Savings is the difference between the new monthly payment and the old monthly payment.

For example, if you save $100 per month on your mortgage payment and have $3,000 in closing costs, the break-even point would be 30 months (2.5 years).

Factors Affecting Break Even

Several factors can influence the break-even point for refinancing:

• Interest rate difference: A larger difference between the old and new interest rates will result in greater monthly savings.
• Loan term: Shorter loan terms generally lead to higher monthly payments but lower total interest paid.
• Closing costs: Higher closing costs will increase the break-even period.
• Property value appreciation: If your home's value increases, you may have more equity to use for refinancing.
• Inflation: Rising prices can affect the real value of your savings over time.

Example Calculation

Let's look at an example to illustrate how to calculate the break-even point for refinancing.

Scenario

• Current mortgage: $300,000 at 6% interest, 30-year term, monthly payment $1,798.54
• New mortgage: $280,000 at 4% interest, 15-year term, monthly payment $2,100.00
• Closing costs: $5,000

Calculation Steps

1. Calculate monthly savings: $2,100.00 (new) - $1,798.54 (old) = $301.46 per month
2. Calculate break-even months: $5,000 / $301.46 ≈ 16.58 months

In this example, the break-even point is approximately 16.58 months (1 year and 4.58 months). This means you would need to keep the new loan for about 16.58 months before the savings from the lower interest rate cover the closing costs.

When to Refinance

Based on the break-even calculation, you should consider refinancing if:

• The break-even period is shorter than the time you plan to stay in the home.
• You can afford the higher monthly payments if the break-even period is longer.
• Interest rates are expected to rise, making it difficult to get a better rate in the future.

You may want to avoid refinancing if:

• The break-even period is longer than the time you plan to stay in the home.
• You need the equity from the home sale to cover other expenses.
• Interest rates are expected to fall, allowing you to refinance at a better rate in the future.