If you're thinking about a refinance, you've probably come across the term "breakeven" and maybe even played around with a breakeven calculator. "Breakeven" refers to the amount of time it takes for the savings generated by a refinance to offset the costs of getting that refinance. If, for example, refinancing saves you $100 a month and costs you $1,000, your breakeven point is ten months.
Too bad it's not that simple.
Lies, More Lies, and Mortgage Breakeven Calculators
The most obvious way to calculate your refinance breakeven point involves finding out what your new payment will be (using a mortgage payment calculator asking a lender), and then subtracting it from your old one. Then, you divide the cost of refinancing by the difference in payments to get the number of months it takes for the savings to pay for your refinance. It's really easy.
It's also really wrong.
The difference between your old payment and your new payment does NOT equal true savings. Want to see for yourself? Using a mortgage payment calculator, input the loan you currently have -- your current balance and interest rate -- and the same term (15 years, 30 years, etc.). Now compare the resulting payment to your payment on your loan. Guess what? The payment on the new loan is lower than the payment on the old loan, even though the rate is the same. You know that can't possibly represent "savings" because your rate doesn't drop. But some loan officers and calculator makers will call it exactly that.
What's really happening here is you're taking the remaining balance on, say, a 30-year loan, and stretching its repayment out over a new term of 30 years. If you've been paying on your current loan for five years, your total repayment period is now 35 years. Repaying your 30-year loan in 35 years naturally makes the payment lower, but it also increases your costs over the life of the loan.
In fact, your breakeven point is "never."
Doing it Right
Even "legitimate" breakeven calculations can be performed several ways and under several assumptions. For example, your choices are not limited to refinance-or-don't-refinance. You could also take the money that the refinance would cost and simply use it to reduce your loan's principal balance. That would get your loan paid off sooner and reduce the interest paid, but not change your payment. You'll find that it takes longer to break even if you include this possibility in your calculations. That's because prepaying your balance reduces the interest expense on your old loan, so the new one would save you less each month and thus it takes longer to break even. So, unless you've got your heart set on a "no-cost" refinance, you'll want to consider this calculation.
Don't Forget Taxes (Sorry!)
How could we forget Uncle Sam? If you deduct mortgage interest from your taxable income, your breakeven point gets pushed out. That's because the tax break effectively lessens the difference between the cost of your old loan and that of the new. Harry Homeowner pays $20,000 of interest a year with his current loan. By refinancing at a cost of $4,000, he could pay $18,000 a year with a new loan. It looks like his breakeven point is two years -- $4,000 in costs divided by savings of $2,000 per year. But Harry is in a 33 percent tax bracket and he deducts mortgage insurance. After taxes, his old mortgage costs $13,500 per year. And after taxes, Harry's new mortgage would cost $12,060 per year -- a savings of $1,440 per year. This stretches his breakeven point to 2.75 years.
Check Out this Comprehensive Refinance Calculator
You CAN get all of these calculations in one place, and choose which result applies to you. LendingTree's Refinance Breakeven Calculator shows you all four results and even tells you if refinancing saves you money over the entire life of the loan. You can even click on the "assumptions" tab and change the inputs, for example, your tax rate -- for a completely customized experience.