Any mortgage refinance is going to cost you cash out of your pocket. How do you know if you’re saving money or losing on the transaction? Calculating your mortgage refinance break-even point will allow you to quickly determine how long it’s going to take to recoup your out-of-pocket expenses and if you’re overpaying things like the loan origination fee and discount points. Here’s an easy-to-follow guide to help you calculate your mortgage refinancing break-even point.
Your Mortgage Refinance Break Even Period
In order to save money on your mortgage refinance you must keep the home loan longer than the break even period. Makes sense you say, but how do I calculate how long it takes to break even?
Your Mortgage Refinance break-even point is the amount of time it takes for the interest rate savings cover your closing costs.
The larger the difference between your refinance mortgage rates and the old interest rate you’re paying on, the faster you’re going to recoup your out-of-pocket expenses. Conversely, the more you pay closing on your new home loan for things like that mortgage loan origination fee, the longer your break-even period will be.
You can calculate how long your break-even point will be by adding up your total closing costs and dividing by how much lower your monthly payment will be. Some financial advisors split hairs by saying you have to factor in the term length of the new loan; going from a 30 year to a 15 year term-length or the other way around affects your break-even point; however, at the end of the day that argument is purely academic and doesn’t make a difference.
Here’s how you can calculate your mortgage refinance break-even period in the real world.
Suppose you purchased your home with a 30-year fixed rate home loan which has a balance of $150,000 at 7 percent. Mortgage refinancing will cost you $4,750 for loan origination and closing costs. Your old payment was $1,330 at 7 percent and mortgage refinancing will get you a payment of $1,135 at 5.5 percent. That’s a savings of ($1,330 – $1,135=$195) $195 per month.
You can calculate how long it will take to recoup your out-of-pocket expenses by dividing your total closing costs ($4,750) by the amount you’re saving each month, in this case $195. In this example it will take 24 months ($4,750/195=24.35) or just over two years to break even.
If you refinance again or sell your home before this two year break-even period is up you’re losing money no matter how low your interest rate. This is why it’s in your best interest to pay less for the fees you can control like the loan origination fee, discount points, as well as avoiding lender junk fees.
You can learn more about paying less for your next home loan when mortgage refinancing by checking out my free Underground Mortgage Videos.