How to Calculate Break Even on Refinance

Refinancing your mortgage can save you money, but it's important to understand when the savings will cover the costs of refinancing. The break even point is the time when your savings from the new loan equal the costs you've incurred. This guide explains how to calculate the break even on refinancing and what it means for your financial situation.

What is Break Even on Refinance?

The break even point on refinancing refers to the time period after which the savings from your new mortgage balance the costs you've paid to refinance. These costs typically include closing costs, points, and any fees associated with the refinancing process.

Understanding your break even point helps you determine whether refinancing is financially beneficial in the short or long term. If your break even point is within a few years, refinancing might be a good investment. If it takes much longer, you might want to wait or consider other financial options.

How to Calculate Break Even on Refinance

Calculating the break even point for refinancing involves comparing the savings from your new mortgage with the costs of refinancing. Here's a step-by-step approach:

Step 1: Calculate Your Savings

First, determine how much you'll save on your monthly mortgage payment with the new loan. This is typically calculated by comparing the interest rates and terms of your current and new loans.

Monthly Savings = (Current Monthly Payment - New Monthly Payment)

Step 2: Determine Your Refinancing Costs

Next, add up all the costs associated with refinancing. These typically include:

Closing costs (2% to 5% of the loan amount)
Points (if applicable)
Appraisal fees
Credit report fees
Other fees

Total Refinancing Costs = Closing Costs + Points + Other Fees

Step 3: Calculate the Break Even Point

The break even point is the time it takes for your savings to cover the refinancing costs. This is calculated by dividing the total refinancing costs by your monthly savings.

Break Even Point (in months) = Total Refinancing Costs / Monthly Savings

For example, if your total refinancing costs are $5,000 and you save $200 per month, your break even point would be 25 months (or about 2 years).

Step 4: Convert to Years

To make the break even point more understandable, convert the number of months to years by dividing by 12.

Break Even Point (in years) = Break Even Point (in months) / 12

Example Calculation

Let's walk through an example to illustrate how to calculate the break even point on refinancing.

Scenario

Current mortgage payment: $2,000 per month
New mortgage payment: $1,600 per month
Refinancing costs: $5,000 (including closing costs, points, and fees)

Step 1: Calculate Monthly Savings

Monthly savings = $2,000 - $1,600 = $400 per month

Step 2: Determine Total Refinancing Costs

Total refinancing costs = $5,000

Step 3: Calculate Break Even Point

Break even point (in months) = $5,000 / $400 = 12.5 months

Step 4: Convert to Years

Break even point (in years) = 12.5 / 12 ≈ 1.04 years (about 1 year and 1 month)

In this example, refinancing would pay for itself within about 1 year and 1 month. This means you would start saving money on your mortgage payments shortly after refinancing.

Key Factors to Consider

When calculating the break even point on refinancing, consider these key factors:

Interest Rate Differences

The difference in interest rates between your current and new loan is a major factor in determining your savings. A lower interest rate will result in higher savings.

Loan Term

The length of your loan term can also affect your savings. A shorter term may result in higher monthly payments but lower total interest over the life of the loan.

Closing Costs and Fees

Closing costs and fees can vary widely and can significantly impact your break even point. Be sure to factor in all costs associated with refinancing.

Market Conditions

Current market conditions, such as interest rate trends and home values, can affect the timing of your break even point. Keep an eye on these factors as you plan your refinancing strategy.

Frequently Asked Questions

What is a good break even point for refinancing?: A good break even point for refinancing is typically within 3 to 5 years. If your break even point is longer than this, you may want to wait or consider other financial options.
How do I know if refinancing is worth it?: Refinancing is worth it if the savings from your new loan cover the costs of refinancing within a reasonable time frame. Use the break even calculator to determine if refinancing is financially beneficial for you.
Can I refinance if my break even point is longer than 5 years?: If your break even point is longer than 5 years, you may want to wait or consider other financial options. However, if you have other financial goals or need to access equity, refinancing might still be a good choice.
How often should I recalculate my break even point?: You should recalculate your break even point whenever there are significant changes in your financial situation, such as changes in interest rates, loan terms, or refinancing costs.
What if I can't afford the closing costs of refinancing?: If you can't afford the closing costs of refinancing, you may want to wait until you have the funds available. Alternatively, you can explore refinancing options that offer low or no closing costs.