When market interest rates are lower than your current mortgage rate, it often makes sense to refinance into a new home loan to take advantage of the savings from lower interest. However, you don’t actually start saving money from day one, thanks to the closing costs and fees associated with making the new mortgage. It’s important to figure out when your “break-even point” is so you can know if refinancing is worth it.
What is a Break-Even Point?
A break-even point is the amount of time it will take for the monthly interest rate savings to equal how much you paid in closing costs. This matters if you are unsure how long you will stay in your current home or if you have other financial goals that might take priority.
How Do I Calculate the Break-Even Point?
The break-even point is calculated by dividing your closing costs by the amount of interest savings you’ll get each month. The result is the number of months it will take for the savings to pay off the upfront money you spent to get the new loan.
Closing costs include all the fees required to create your mortgage. That includes things like appraisal fees, credit report fees, underwriting fees, origination fees, flood certification fees, tax status research fees, etc. Closing costs can run between 3%-6% of the mortgage loan amount. So, if you are getting a refinance loan for $200,000, your closing costs could range from $6,000 to $12,000.
You can determine your potential interest savings by looking at your most recent mortgage statement. Then subtract what your new payment would be at the lower rate. You can find online calculators to help you figure out the payment info. Make sure it takes into account your property taxes and homeowners’ insurance.
Once you have these two numbers, you can come up with your break-even point. For example, if you are paying $6000 in closing costs and you will be saving $200 a month with the refinance loan, your break-even point would be 30 months ($6,000/$200=30.)
Does My Break-Even Point Make Financial Sense?
This break-even point can help you see if the upfront cost is worth it. In the example above, if you plan to sell the home within two and a half years, you will never realize the savings and refinancing does not make sense. Or if you are close to the end of your mortgage, it may not be able to benefit much from the savings before you finish the loan. In some cases, you may want to use that chunk of money you’d use on closing costs to invest in some other avenue that could bring a greater return on investment. And then of course, sometimes, the break-even point is quick and you can end up saving tens of thousands of dollars on interest. In any case, the break-even point helps you determine if refinancing is a good choice.
We hope this information helps you to better understand an important consideration when you consider refinancing your mortgage. Give us a call today if you'd like to review your mortgage refinance options and find out the break-even point on a new mortgage.