How to calculate the break-even point in a mortgage refinance
Quick insights
- The break-even point is a key metric in mortgage refinancing that helps homeowners determine whether the costs of refinancing are offset by the savings.
- Factors such as interest rates, loan terms, and closing costs can influence the break-even point, which can be calculated by dividing total closing costs by monthly savings.
- Understanding the break-even point can help homeowners make informed decisions about refinancing and potentially avoid costly mistakes.
Refinancing your mortgage can sometimes feel like solving a puzzle—there are costs, savings and timing to consider. One way that homeowners might evaluate whether a refinance makes sense is by looking at the break-even point. The break-even point is the moment when potential monthly savings from the new home loan may offset upfront costs of refinancing. While it’s not the only factor in a refinance decision, understanding the break-even point could give you a clearer picture of how long it might take before the refinance starts working in your favor. Actual results depend on your specific financial situation.
Defining the break-even point
The break-even point is the point at which the total savings from refinancing equals the total costs of refinancing. It can be a critical metric that helps homeowners determine whether refinancing is a financially viable decision. The break-even point is significant because it allows homeowners to weigh the financial benefits of refinancing against the costs. If the break-even point is too long, it may not be worth refinancing, as the costs may outweigh the benefits. On the other hand, a shorter break-even point can make refinancing a more appealing option.
Factors that could affect the break-even point
There are several elements that may influence when, or if, you reach your break-even point. Each borrower’s situation is different, but here are some useful considerations:
- Closing costs: Refinancing often comes with fees, such as appraisal, title or lender charges. Higher closing costs might extend the time it takes to break even, while lower costs could shorten it.
- Interest rate changes: A lower interest rate may reduce your monthly payment, possibly helping you reach your break-even point sooner. However, if the rate difference is small, the savings might take longer to cover the upfront expenses.
- Loan term: Extending your mortgage term could reduce your monthly payments but might also delay your break-even point. Shortening your term means higher monthly mortgage payments, but the interest savings might offset costs faster.
- How long you plan to stay in the home: If you might sell or move in a few years, you may not reach the break-even point
- Extra payments or prepayments: Making additional payments could help you reach your break-even point more quickly. However, this depends on your overall financial goals and flexibility.
Calculating the break-even point
To calculate the break-even point, homeowners can use a simple formula:
Break-even point = Total closing costs ÷ Monthly savings
For example, if the total closing costs are $5,000 and the monthly savings are $200, the break-even point would be 25 months, just over two years:
$5,000 / $200 = 25 months
After that, the monthly savings could begin to outweigh the upfront costs. This example is for illustrative purposes only; actual results will depend on your loan size, interest rate and associated fees. You may want to consider using online mortgage calculators or consulting with a Home Lending Advisor to simplify the process and ensure accurate calculations.
Cash-out refinancing
A cash-out refinance adds another layer to the break-even calculation because it involves tapping into your home equity. The costs, benefits and timing may shift depending on how you use the funds. Here are some things to consider:
- Higher loan balance: Borrowing more may raise monthly payments, which could extend the break-even timeline. For example, if your current mortgage is $200,000 and you take out $50,000 in cash, your new loan balance would be $250,000. Even if your interest rate is slightly lower, your monthly payment might be higher, so it could take longer to offset the upfront costs.
- Interest rate impact: A lower interest rate may help offset costs, while a higher rate might delay savings.
- Use of funds: How you use the cash (home improvements, debt consolidation or other expenses) might influence whether the refinance feels worthwhile.
- Time in home: Staying long term could make a cash-out refinance more beneficial, whereas a short-term stay might not allow enough time to break even.
Cash-out refinancing may not be suitable for all borrowers. Carefully review your financial objectives and consult with a mortgage professional.
In summary
The break-even point can be a helpful guide when thinking about mortgage refinancing. There are various factors that could influence your timeline like closing costs, interest rate changes and how long you plan on staying in the home. Reviewing the numbers, considering your long-term plans and speaking with a Home Lending Advisor might help you decide whether refinancing could be a smart move for your unique situation. Individual results will vary.
