Refinance Break Even Calculation

Refinancing a loan can save you money, but it's important to understand when the savings will outweigh the costs. The refinance break even calculation helps you determine the point at which the savings from refinancing exceed the costs of refinancing. This guide explains how to perform this calculation, the factors that affect it, and how to use the results to make informed decisions.

What is Refinance Break Even?

The refinance break even point is the number of months or years after refinancing when the cumulative savings from the lower interest rate equal the costs of refinancing. These costs typically include closing costs, points, and any fees associated with the new loan.

For example, if you refinance a $200,000 mortgage with a 5% interest rate and pay $5,000 in closing costs, the break even point is the time it takes for the savings from the lower rate to cover the $5,000. If the savings cover the costs in 6 months, refinancing is a good decision.

How to Calculate Refinance Break Even

The formula for calculating the refinance break even point is:

Break Even Months = (Refinance Costs) / (Monthly Savings)

Where:

Refinance Costs = Total closing costs + points paid
Monthly Savings = Difference in monthly payments between the original loan and the refinanced loan

To calculate the monthly savings, you need to know the interest rates and terms of both the original loan and the refinanced loan. You can use an amortization calculator to determine the monthly payments for each loan.

Factors Affecting Break Even Point

Several factors can affect the refinance break even point, including:

Interest Rate Difference: A larger difference between the original interest rate and the refinanced interest rate will result in higher monthly savings.
Loan Term: A longer loan term will result in higher monthly payments and lower monthly savings.
Refinance Costs: Higher closing costs and fees will increase the refinance costs and extend the break even point.
Loan Amount: Larger loan amounts will result in higher monthly payments and lower monthly savings.

Understanding these factors can help you make informed decisions about refinancing and determine the best time to refinance.

Example Calculation

Let's say you have a $200,000 mortgage with a 6% interest rate and monthly payments of $1,200. You refinance the loan at 4% with a $5,000 closing cost.

The monthly savings from the lower interest rate are $1,200 - $1,100 = $100. The refinance costs are $5,000. The break even point is $5,000 / $100 = 50 months, or about 4.2 years.

This means that after about 4.2 years, the savings from the lower interest rate will cover the $5,000 closing cost. If you plan to stay in the home for less than 4.2 years, refinancing may not be a good idea.

FAQ

What is the difference between break even point and payback period?

The break even point is the time it takes for the savings from refinancing to equal the costs of refinancing. The payback period is the time it takes to recover the total investment in refinancing, including both the costs and the savings.

How do I know if refinancing is worth it?

Refinancing is worth it if the break even point is less than the time you plan to stay in the home. If the break even point is longer than your remaining mortgage term, refinancing may not be a good idea.

What are the costs of refinancing?

The costs of refinancing typically include closing costs, points, and any fees associated with the new loan. Closing costs can range from 2% to 5% of the loan amount, and points can range from 0.5% to 2% of the loan amount.