Whether your refinancing goal is to lower your interest rate, lower your monthly payments, pay off your mortgage sooner, or take out some cash for a major project, it’s important to calculate and consider the break-even point.
Whatever type of mortgage refinance you select, there are going to be costs – points, fees, insurance, etc. Although your monthly payments may be lower immediately, you don’t see the full benefit of your refinance until all of those costs are covered. That’s the break-even point. It’s simply a matter of measuring your savings against your costs over time.
To make a rough measure of your break-even point, divide costs by savings. For example, the total costs of your refinance are $4500. You will save $200 per month by refinancing. Dividing $4500 by $200, you get 22.5, which is the number of months it will take you to break even – just under two years.
So what are the costs of refinancing? Typically, there are a variety of charges, such as: points, application fees, origination costs, appraisal costs, attorney fees, credit report, inspection fees, title insurance, Private Mortgage Insurance (PMI), and underwriting. Your loan officer can provide this information. The list of costs will appear on your Loan Estimate and again on your Closing Disclosure form. Make a list of all your costs and total them.
How much lower will your monthly payments be? Your mortgage banker / loan officer can do a rough calculation to estimate your monthly payment at the new rate. Subtract your new monthly payment from your current monthly payment to come up with your monthly savings amount.
Divide your total costs by one month’s savings to come up with the number of months it will take to recoup your costs. That’s roughly your break even point.
(Note: your after-tax savings will be lower than your monthly savings amount, so the number of months it will take to break even is larger. To estimate after-tax savings, subtract your tax rate – .15, .28, for example – from 1. The difference is your after-tax rate. Multiply your monthly savings amount by your after-tax rate to come up with your after-tax savings. In the example above, at a 28% tax rate, the after-tax savings is $144 and the break-even point is 31.25 months – just over two-and-a-half years.)
Time is a very important part of the calculation. How long do you anticipate staying in your home? The National Association of REALTORS® 2016 Profile of Home Buyers and Sellers reports that, “Overall, buyers expect to live in their homes for a median of 12 years, while 18 percent say that they are never moving.” While many people move to have more (or less) space, some hasten the process to “flip” a property (fix it up and sell it quickly in a seller’s market) or to be closer to work or family.
Evaluating the likelihood that you will stay or leave your home is a vital step and something you should consider before you refinance. If you plan to leave your home before you recover the costs of refinancing (break even), you may want to reconsider your refi – or to discuss refinancing options that will lower your initial costs and hence shorten the break-even period.
If you are considering refinancing, you can explore more mortgage refinancing options here. And whatever your reason for refinancing, your decision needs to make financial sense. Your loan officer can help you evaluate your needs and the costs and benefits.