Are you thinking about taking advantage of lower interest rates with a refinance?
The most important consideration for homeowners who want to refinance their mortgage is whether the savings outweigh the costs.
What's in this article?
To determine this crucial factor, borrowers can calculate the refinance break-even point, which conveys how long it will take for your refinance savings to offset the up-front costs.
In this article, we’ll explain how to calculate the refinance break-even point to help you determine whether it makes sense to refinance.
What is the refinance break-even point?
Refinancing a mortgage replaces your current loan with a new one.
The purpose is usually to access lower rates, adjust the length of your loan term or tap into your home equity.
Just like when you obtained your original mortgage, you’ll have to pay closing costs and fees—such as appraisal and origination fees—which can add up to 2-6% of the loan amount.
Is refinancing worth it?
Calculating the refinance break-even point answers the question, “Is it worth it to refinance my mortgage?”
It marks the point in time when the savings from lower monthly mortgage payments equals the costs of refinancing.
If you plan to stay in your home long enough to pass the break-even point, refinancing can result in significant savings over the life of the loan.
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How to calculate your refinance break-even point
The break-even point is a simple calculation which takes a few steps.
Let’s take a look at the process.
1. Determine the costs to refinance
Your total closing costs include:
- Loan origination fees
- Appraisal fees
- Title search fees
- Attorney fees
They generally equal about 2-6% of the loan amount.
For this example, let’s say your closing costs equal $4,500.
2. Calculate your monthly savings
Next, calculate how much you will save each month with your new loan compared to your current mortgage.
If you currently pay $1,500 per month and your new mortgage payment will be $1,200, you will subtract the new amount from the old one to get your savings.
$1,500 – $1,200 = $300 monthly savings
3. Divide your closing costs by your monthly savings
Now, we can calculate your break-even point with the following formula:
Break-even point = Total closing costs / Monthly savings
If we plug in the numbers from the previous two steps, we divide $4,500 by $300 for a break-even point of 15 months.
Based on this example, the borrower would take 15 months of lower monthly payments to recoup the $4,500 spent on closing costs.
Factors that impact your refinance break-even point
Is it possible to control how quickly you reach your break-even point?
Understanding the factors influencing this point can help you make the best decisions.
Interest rates
A significant rate drop will result in greater monthly savings, while a smaller drop could extend the time it takes to reach your break-even point.
It’s impossible to control market rates, but homeowners can help themselves get a better rate by improving their credit scores and increasing the equity in their homes.
Loan term
Shortening or lengthening your loan term also directly impacts your break-even point.
For example, shortening your loan term from 30 to 15 years will increase your monthly payment and help you repay the loan faster, but it can delay your break-even point.
Extending your loan to 30 years will lower your monthly payments and increase the interest you’ll pay over the life of the loan, but you can reach your break-even point faster.
Closing costs and fees
The higher your closing costs, the longer it will take you to recoup them through your monthly savings.
Additionally, borrowers must consider the impact of other potential fees such as prepayment penalties, if they refinance prior to the time limit stipulated in the original mortgage.
Loan amount and type
Consider that larger loan amounts can provide a greater savings opportunity with a lower interest rate.
Adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) also have different structures that impact your monthly payments and overall costs.
When does it make sense to refinance?
It may seem tempting to refinance as soon as rates start to fall, but many other factors are at play in determining whether it’s the right decision for you.
Refinancing can be a good idea in the following types of scenarios:
- You plan to stay in your home for several more years.
- You can secure a lower interest rate.
- You want to switch from an ARM to an FRM.
- You need to lower your monthly mortgage payments.
- You want to pay off your loan faster.
- You want to access the equity in your home with a cash-out refinance.
Compass Mortgage can help you make the best decision for your financial situation.
We will explain your refinance options to see what offers you the greatest benefit, discuss the potential terms for which you qualify and guide you through each step of the process.
Common mistakes when calculating break-even point
The break-even point is a helpful tool for homeowners who want to refinance, but borrowers must be careful to avoid these three common mistakes that could throw off their calculation:
- Forgetting to factor in property taxes, homeowners insurance or mortgage insurance
- Not considering how refinancing fits into bigger-picture financial goals
- Assuming you’ll stay in the home longer than you will
Ensure refinancing aligns with your long-term financial goals, such as future job changes, lifestyle changes and retirement.
Being realistic about the future and how long you intend to stay in your home is important.
The long-term impact of refinancing
The best part about the refinance break-even point is that once you reach it, you get to enjoy the savings that come along with lower monthly payments—potentially thousands of dollars over the life of the loan.
However, borrowers must also consider the impact of resetting their loan term, especially if they refinance into another 30-year mortgage.
The experienced loan officers at Compass Mortgage can help you weigh the costs and benefits to determine the best course of action.
Apply today with Compass Mortgage
Compass Mortgage treats our borrowers like family. Together, we’ll find the most affordable loan for your home!
Apply online today if you are ready to unlock savings with a refinance.
Give us a call at (877) 677-0609. We’re ready to answer any and all questions you may have about the process.