How to Calculate Break Even Point on Refinance

What is the Break Even Point?

The break-even point is the point at which the total cost of refinancing equals the total savings from the new mortgage. It's calculated by comparing the costs of refinancing (closing costs, fees, etc.) with the savings from the lower interest rate or different loan terms.

Understanding the break-even point helps you determine whether refinancing is financially beneficial in the short term. If the break-even point occurs after your planned refinancing period, you might want to reconsider the decision.

How to Calculate Break Even Point on Refinance

Calculating the break-even point for refinancing involves comparing the costs and savings associated with the new mortgage. Here's a step-by-step guide:

Step 1: Gather Your Information

You'll need the following information to calculate the break-even point:

• Current mortgage balance
• Current interest rate
• New interest rate offered by the lender
• Estimated closing costs for refinancing
• Loan term (how long you plan to keep the mortgage)

Step 2: Calculate Monthly Payments

Use the mortgage payment formula to calculate your current and new monthly payments:

Step 3: Calculate Total Interest Savings

Multiply the difference in monthly payments by the number of months in the loan term to find the total interest savings.

Step 4: Calculate Break-Even Point

The break-even point is calculated by dividing the total closing costs by the monthly savings from the new mortgage. This gives you the number of months it will take for the savings to cover the costs of refinancing.

Step 5: Interpret the Results

If the break-even point is less than the number of months you plan to keep the mortgage, refinancing is likely a good financial decision. If the break-even point is longer than your planned mortgage term, you might want to reconsider.

Example Calculation

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

Scenario

• Current mortgage balance: $200,000
• Current interest rate: 5% (0.4167% monthly)
• New interest rate: 3.5% (0.2917% monthly)
• Estimated closing costs: $3,000
• Loan term: 30 years (360 months)

Step 1: Calculate Current Monthly Payment

Using the mortgage payment formula:

P = $200,000 [ (0.004167(1 + 0.004167)^360) / ((1 + 0.004167)^360 - 1) ]

Current monthly payment = $1,128.44

Step 2: Calculate New Monthly Payment

Using the mortgage payment formula with the new rate:

P = $200,000 [ (0.002917(1 + 0.002917)^360) / ((1 + 0.002917)^360 - 1) ]

New monthly payment = $985.67

Step 3: Calculate Monthly Savings

Monthly savings = $1,128.44 - $985.67 = $142.77

Step 4: Calculate Break-Even Point

Break-even point = $3,000 / $142.77 ≈ 21 months

Interpretation

In this example, the break-even point is 21 months. This means that it will take approximately 21 months for the savings from the lower interest rate to cover the $3,000 in closing costs. If you plan to keep the mortgage for less than 21 months, refinancing might not be financially beneficial.

Factors to Consider

While the break-even point calculation provides a useful estimate, there are other factors to consider when deciding whether to refinance:

Closing Costs

Closing costs can vary widely depending on the lender and the type of loan. Some lenders offer low or no closing costs, while others may charge higher fees. Be sure to factor in all potential costs when calculating the break-even point.

Loan Term

The length of your loan term can significantly impact the break-even point. Shorter loan terms may result in higher monthly payments but can also lead to a lower break-even point. Longer loan terms may have lower monthly payments but a higher break-even point.

Interest Rate Changes

Interest rates can fluctuate over time. If rates rise after you refinance, your monthly payments may increase, potentially offsetting the savings. Consider how changes in interest rates could affect your break-even point.

Other Financial Goals

Refinancing may not always be the best financial decision. Consider your overall financial goals, such as paying off debt, saving for retirement, or investing in other opportunities. Sometimes, keeping your current mortgage may be the more practical choice.