How to Calculate Refinance Break Even Point

Refinancing your mortgage can save you money, but it's important to understand when it makes financial sense. The refinance break even point is the number of months it will take for the savings from refinancing to equal the costs of refinancing. This guide will explain how to calculate it and what the results mean.

What is Refinance Break Even Point?

The refinance break even point is the period after which the savings from refinancing your mortgage will offset the costs of refinancing. It helps you determine whether refinancing is worth the effort based on your current financial situation.

Key factors that affect the break even point include:

Current mortgage interest rate
New mortgage interest rate
Refinancing fees
Length of the mortgage term
Current mortgage balance

Note: The break even point assumes you keep your mortgage for the entire period. If you sell or refinance before then, the actual savings may differ.

How to Calculate Refinance Break Even Point

The formula for calculating the refinance break even point is:

Break Even Point (months) = Refinancing Fees / (Monthly Savings from Lower Rate)

Where:

Refinancing Fees - The total cost of refinancing (closing costs, appraisal fees, etc.)
Monthly Savings from Lower Rate - The difference in monthly payments between your current and new mortgage

To calculate the monthly savings:

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

Once you have both values, you can calculate the break even point in months. For example, if refinancing fees are $3,000 and you save $100 per month, the break even point would be 30 months.

Example Calculation

Let's say you have a $200,000 mortgage with a 6% interest rate and a 30-year term. Your current monthly payment is $1,264.70. You're considering refinancing to a 4% rate with $3,000 in closing costs.

First, calculate the new monthly payment:

New Monthly Payment = P * (r(1+r)^n)/((1+r)^n - 1)

Where P = $200,000, r = 4%/12 = 0.003333, n = 30*12 = 360

New Monthly Payment ≈ $995.54

Next, calculate the monthly savings:

Monthly Savings = $1,264.70 - $995.54 = $269.16

Finally, calculate the break even point:

Break Even Point = $3,000 / $269.16 ≈ 11.15 months

This means it would take about 11 months of paying the lower rate to recoup the $3,000 in refinancing fees.

Interpreting the Results

The break even point helps you decide whether refinancing is worth it based on your financial situation:

If the break even point is less than the length of your mortgage, refinancing may be beneficial
If the break even point is longer than your mortgage term, refinancing may not be worth the cost
A shorter break even point means you'll save money faster

Other factors to consider when interpreting results:

Your ability to pay the new monthly payment
Changes in interest rates during the break even period
Potential tax benefits from refinancing

Remember: The break even point is an estimate. Actual savings may vary based on market conditions and your personal financial situation.

Frequently Asked Questions

What is a good refinance break even point?

A good break even point depends on your mortgage term. For a 30-year mortgage, a break even point of less than 5 years (60 months) is generally considered good. For shorter terms, the break even point should be even shorter.

Does the break even point include closing costs?

Yes, the break even point calculation includes all refinancing fees, including closing costs. These are the costs you'll need to recoup through savings on your mortgage payments.

How does the break even point change with different interest rates?

A lower interest rate will result in higher monthly savings, which will decrease the break even point. Conversely, a higher interest rate will increase the break even point.

Should I consider other factors besides the break even point?

Yes, consider your ability to pay the new monthly payment, potential tax benefits, and changes in interest rates. The break even point is just one factor in your refinancing decision.