How to Calculate Break Even Point on 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 time when the savings from your new mortgage equal the costs of refinancing. This guide explains how to calculate it and what it means for your financial situation.

What is the Break-Even Point in Mortgage Refinancing?

The break-even point in mortgage refinancing is the time period after which the savings from your new mortgage outweigh the costs of refinancing. It's calculated by comparing the interest savings from the new mortgage with the closing costs of refinancing.

For example, if you refinance for a lower interest rate but pay $5,000 in closing costs, the break-even point is the number of months it will take for the interest savings to equal $5,000.

Why Calculate the Break-Even Point?

Calculating the break-even point helps you determine whether refinancing is worth it. If the break-even point is longer than the expected term of your mortgage, refinancing might not be cost-effective. Conversely, if the break-even point is short, refinancing could save you money in the long run.

Key considerations include:

The current interest rate and your new rate
Closing costs of refinancing
The length of your mortgage term
Your financial goals and timeline

How to Calculate the Break-Even Point

The break-even point can be calculated using the following formula:

Break-Even Point (months) = Closing Costs / (Monthly Savings)

Where Monthly Savings = (Original Monthly Payment - New Monthly Payment) × 12

To calculate:

Determine your original monthly payment and the new monthly payment after refinancing.
Calculate the monthly savings by subtracting the new monthly payment from the original monthly payment.
Multiply the monthly savings by 12 to get the annual savings.
Divide the closing costs by the annual savings to get the break-even point in years.
Convert years to months by multiplying by 12.

For example, if your original monthly payment is $1,500, your new monthly payment is $1,200, and your closing costs are $5,000:

Monthly Savings = ($1,500 - $1,200) = $300

Annual Savings = $300 × 12 = $3,600

Break-Even Point = $5,000 / $3,600 ≈ 1.39 years

Convert to months: 1.39 × 12 ≈ 16.67 months

Worked Example

Let's say you have a $300,000 mortgage with a 5-year term at 6% interest. Your current monthly payment is $6,750. You refinance to a 4% interest rate with $7,500 in closing costs.

Your new monthly payment would be approximately $5,833.33.

Monthly Savings = $6,750 - $5,833.33 = $916.67

Annual Savings = $916.67 × 12 = $11,000

Break-Even Point = $7,500 / $11,000 ≈ 0.68 years

Convert to months: 0.68 × 12 ≈ 8.17 months

This means you would need to stay in your home for about 8.17 months to break even on the refinancing costs.

Key Factors Affecting Break-Even

Several factors can influence the break-even point of mortgage refinancing:

Interest Rate Difference: A larger difference between your current and new rate will increase savings.
Closing Costs: Higher closing costs will increase the break-even point.
Loan Term: Shorter loan terms generally result in higher monthly payments and faster break-even points.
Home Value: Higher home values may allow for larger refinancing amounts, potentially reducing the break-even point.
Credit Score: A better credit score may qualify you for a lower interest rate, reducing the break-even point.

FAQ

What if my break-even point is longer than my mortgage term?

If the break-even point is longer than your mortgage term, refinancing may not be cost-effective. You should consider whether the potential savings are worth the closing costs and whether you plan to stay in the home long enough to benefit from the lower rate.

How do I know if refinancing is worth it?

Refinancing is worth it if the break-even point is shorter than your expected stay in the home. You should also consider other factors such as the convenience of a lower payment, the ability to access home equity, and changes in your financial situation.

Can I use this calculator for different types of refinancing?

Yes, this calculator can be used for any type of mortgage refinancing, including rate-and-term refinancing, cash-out refinancing, and home equity refinancing. The formula remains the same, but you may need to adjust the closing costs and loan terms accordingly.