What is the Break-Even Point on a Refinance?
The break-even point on a refinance tells you how long it takes you to recoup refinance closing costs. Some homeowners overlook this important calculation and focus more on the interest rate or APR they’re being offered, and end up spending more than they should.
Before you decide which lender to choose when you’re rate shopping, make sure you can answer the question: What is the break-even point on a refinance?
How to find the break-even point on a refinance in 4 steps
You don’t really need a break-even calculator to figure how long it will take to recoup the costs of refinancing to lower your payment. However, you do have to know which closing costs to include in your break-even analysis, or you could end up with a faulty result that doesn’t tell you if you’re getting the best refinance bang for the buck.
Follow these steps to get the best break-even point results:
1. Add up the loan costs from your loan estimate
You can negotiate lender costs on refinances, so it’s important to focus on them separately from the other refinance fees. These are the charges on Page 2, sections A and B of your loan estimate under the heading “Loan Costs” and include:
- Origination fees
- Discount fees
- Application fees
- Underwriting fees
- Appraisal fee
- Credit report fee
- Flood certification fee
- Flood monitoring fee
- Tax monitoring fee
- Tax status research fee
2. Add up the fees you can shop for separately
Many homeowners don’t realize they can shop for their own title company on a refinance. That’s because the seller or real estate agent often choose them on a purchase loan, leading homeowners to assume the lender chooses the title company on a refinance. The fees in the “Services You Can Shop For” on Page 2, section C of your loan estimate should be added on their own so you can compare them on each lender’s offer.
3. Calculate your monthly payment savings
Grab a copy of your most recent mortgage statement to verify your current monthly payment. Subtract the new payment from your current monthly payment to get your monthly savings.
4. Divide your total loan costs by your monthly savings
This figure gives you the number of months it takes to recoup the closing costs charged for your refinance, also known as the “break-even point.”
Here’s a quick example of the break-even point in action, assuming the lender and title fees are $6,000 and your monthly savings is $200 per month.
|Breakeven||30 months ($6,000/$200 = 30 months)|
If you plan on keeping the home for at least 30 months, then the refinance makes sense. If not, you’ll end up spending more money than you save by refinancing.
THINGS TO KNOW
Some lenders recommend using the “total closing costs” referenced in the “other costs” section of Page 2 of your loan estimate. This could give you misleading break-even results because it includes ongoing fees that will ultimately be the same with each lender, even if they are disclosed differently on initial loan estimates. Lenders often require you to deposit funds into an escrow account for payment of your property taxes and insurance, and each lender follows the same federal standards for setting up the account, so ignore any differences in these costs when you’re calculating your refinance break even.
How do I use a break-even calculator?
Most mortgage refinance calculators include your break-even point, along with other valuable information you should consider before you make a decision to refinance. Those factors include:
Your original loan amount. This is important to determine how much principal and interest you’ve paid since you took the loan you’re replacing and compares how much interest you’ll pay if you stick with your current loan or pay off your old loan.
When your original loan started. You may need to dig up your closing papers to find the date your first mortgage payment was due. Your credit report will also show this. It helps the calculator precisely calculate how much you’ve paid into your current mortgage.
Your original loan term. You should be able to find this information on your current mortgage statement.
Your current interest rate. You’ll also find this information on your most recent mortgage statement.
The term of your new mortgage. Decide if you’ll refinance to a shorter-term mortgage or start the clock over with a 30-year fixed rate to get the lowest monthly payment.
The interest rate of your current mortgage. If you’ve done some mortgage shopping, enter your best interest rate quote here.
Closing costs. Use steps one and two above and enter the total.
How long you plan to own your home. If you plan to sell your home in a set time period, be sure to enter the number of years in this section. The calculator will tell you if you’ll recoup the refinance costs within that time.
What the calculator tells you:
Your monthly payment savings. The primary motivation for refinancing for most borrowers is to save money monthly. Although it’s the figure most homeowners use when deciding whether they should refinance, it’s not the only thing you should consider.
Your lifetime savings. The calculator adds the interest you’ve paid during the time you’ve had your current loan to the interest you’ll pay on your new mortgage so you get a long-term picture of your refinance savings.
Your break-even point. This is the same calculation we described above.
Your payoff time. You’ll get a glimpse of how long it will take you to pay off your home loan based on your savings.
THINGS TO KNOW
One drawback to refinancing at a lower rate is you pay less deductible mortgage interest, which may affect how much you owe in taxes at the end of the year. It’s not a bad idea to run your refinance numbers by a tax professional to see if the refinance will affect your tax bill.
Is there a refinance break even rule of thumb?
The Consumer Financial Protection Bureau (CFPB) Home Loan Toolkit suggests you should only refinance if you can recoup your costs in two years. However, if you’re in your “forever” home or plan to live there longer than your break-even period, the refinance still makes financial sense even if you won’t break even for more than two years.
If you’re planning to sell your home or pay down your mortgage with the money you’ll be receiving from another home sale, a large earnings bonus or another cash windfall before the break-even period is up, you might want to delay or skip refinancing altogether.
FAQs about the break-even point on a refinance
How do I calculate when I’ll break even on a cash-out refinance?
If you have enough equity, you can replace your current mortgage with a larger loan and pocket the difference in cash. This is called a cash-out refinance, and calculating when you’ll break even depends on what you’re using the cash for.
- If you’re consolidating debt, you’ll add the monthly payments of the debts you’re paying off to any mortgage payment savings to come up with your total savings. Then divide your closing costs by your savings to calculate your break even. One caveat: You won’t be able to write off the mortgage interest on your cash-out if you use it to pay off debt.
- If you’re making home improvements, the goal is typically to add value to your home, which you won’t know unless you get an appraisal after your refinance. You may want to consider a fixer-upper loan, which allows you to borrow money to fix up your home based on its value after the improvements are made. If the increase in value is more than the renovation refinancing costs, then the refinance is worth it. An added bonus: Extra cash borrowed for home renovations may be tax-deductible.
Can I calculate a break even on a refinance to a shorter-term loan?
Yes, but you’ll probably want to use a refinance calculator to see the lifetime interest savings since you won’t typically see any monthly savings with a shorter term (such as switching from a 30-year term to a 15-year mortgage).
The table below gives you an idea of how much interest you save just in the first five years of a 30-year, fixed-rate mortgage at 3.25% versus a 15-year, fixed-rate mortgage at 2.5% on a $300,000 loan balance.
|Loan term||30-year fixed rate||15-year fixed rate|
|Total interest paid over the life of the loan||$170,022.82||$60,066.18|
The bottom line:
- If you can swing the extra $694.75 you’ll pay each month for the 15-year term, you’ll save $109,956.64 over the life of the loan.
- To calculate your monthly interest savings, divide $109,956.64 by 180 months (15 years) which equals $610.87.
- Assuming you have $6,000 worth of closing costs you’d break even on the costs in 9.8 months ($6,000/$610.87 = 9.8 months).
Is it worth it to pay mortgage points when I refinance?
Yes, if you’ll break even on the cost of the mortgage points before you sell your home. Mortgage points allow you to “buy down” a lower interest rate, and typically only make sense if you plan to live in your home for a long time. One point typically equals 1% of your loan amount, and reduces your rate by up to .25% percentage points, although the cost may vary by lender. You may be able to deduct refinance points on your taxes.