How to Calculate Break Even Point for Mortgage 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 point at which the savings from refinancing equal the costs of refinancing. This guide explains how to calculate the break even point for mortgage refinancing and what it means for your financial situation.

What is the Break Even Point?

The break even point is the time period after which the savings from refinancing your mortgage will cover the costs of refinancing. It's a key metric that helps you determine whether refinancing is financially beneficial.

For example, if your break even point is 5 years, it means that after 5 years of refinancing, the savings from your lower interest rate will equal the fees and closing costs you paid to refinance.

Break Even Formula

The break even point for mortgage refinancing can be calculated using the following formula:

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

Where:

Refinancing Costs = Closing costs + points paid + other fees
Monthly Savings = Original monthly payment - New monthly payment

The formula calculates how many months it will take for the monthly savings from refinancing to cover the upfront costs of refinancing.

How to Calculate Break Even

To calculate the break even point for your mortgage refinancing, follow these steps:

Calculate your refinancing costs: Add up all the fees associated with refinancing, including closing costs, points paid, and other expenses.
Determine your monthly savings: Calculate the difference between your original monthly payment and your new monthly payment after refinancing.
Apply the formula: Divide the total refinancing costs by the monthly savings to find the break even point in months.
Convert to years: Divide the number of months by 12 to get the break even point in years.

Tip: If your break even point is less than 5 years, refinancing is likely a good financial decision. If it's more than 5 years, you may want to consider other options.

Worked Example

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

Example Scenario

Original mortgage balance: $200,000
Original interest rate: 6%
Original loan term: 30 years
New interest rate: 4%
Refinancing costs: $3,000 (closing costs + points)

Step 1: Calculate original monthly payment

The original monthly payment can be calculated using the mortgage payment formula:

M = P [i(1 + i)^n] / [(1 + i)^n - 1]

Where:

M = Monthly payment
P = Principal loan amount ($200,000)
i = Monthly interest rate (6%/12 = 0.005)
n = Number of payments (30 years × 12 = 360)

Original monthly payment = $200,000 [0.005(1.005)^360] / [(1.005)^360 - 1] ≈ $1,264.14

Step 2: Calculate new monthly payment

Using the same formula with the new interest rate of 4%:

New monthly payment = $200,000 [0.00333(1.00333)^360] / [(1.00333)^360 - 1] ≈ $1,002.46

Step 3: Calculate monthly savings

Monthly savings = Original monthly payment - New monthly payment = $1,264.14 - $1,002.46 = $261.68

Step 4: Calculate break even point

Break even point (in months) = Refinancing costs / Monthly savings = $3,000 / $261.68 ≈ 11.46 months

Break even point (in years) = 11.46 months / 12 ≈ 0.95 years (about 11 months)

Interpretation: In this example, the break even point is approximately 11 months. This means that after about 11 months of refinancing, the savings from the lower interest rate will cover the $3,000 in refinancing costs.

Key Factors Affecting Break Even

Several factors can affect the break even point for mortgage refinancing, including:

Interest rate difference: A larger difference between the original and new interest rates will result in greater monthly savings and a shorter break even point.
Loan term: Shorter loan terms generally result in higher monthly payments and faster payoff, which can affect the break even point.
Refinancing costs: Higher refinancing costs will increase the break even point, as it will take longer for the monthly savings to cover the costs.
Property value: If the property value increases, the equity you have in the home can be used to reduce the refinancing costs.

Understanding these factors can help you make a more informed decision about whether refinancing is the right choice for your situation.

FAQ

What is a good break even point for mortgage refinancing?

A good break even point for mortgage refinancing is typically less than 5 years. If your break even point is less than 5 years, refinancing is likely a good financial decision. If it's more than 5 years, you may want to consider other options.

How do I know if refinancing is worth it?

Refinancing is worth it if the break even point is less than 5 years and you expect to stay in the home for at least that long. Other factors to consider include the interest rate difference, refinancing costs, and your financial situation.

Can I use the break even point to compare different refinancing options?

Yes, the break even point is a useful tool for comparing different refinancing options. By calculating the break even point for each option, you can determine which one will save you the most money in the long run.