What Is The Refinance Break Even Point?
Hanna Kielar8-minute read
March 28, 2023
If you’re looking to refinance your mortgage to take cash out for a home improvement, to consolidate debt or even to save money, you want to know how to figure out whether it makes sense to take on a new mortgage. One way to figure that out is to calculate the break-even point for a refinance.
We’ll show you how to calculate this break-even point and discuss a general rule you can use to figure out whether refinancing makes sense.
What Is The Mortgage Refinance Break-Even Point?
The refinance break-even point is the point at which it starts making financial sense to refinance and take on the terms of a new mortgage.
Before deciding if you should refinance, you’ll want to look at your goals and your current mortgage terms. You’ll need to make sure that refinancing will save you more money than what you’ll pay in closing costs and interest on the new mortgage.
If the closing costs and interest rate on the new loan are lower than what you’d pay on your current loan, you’ve hit your break-even point. If they’re higher, refinancing may not be the best financial decision.
As you shop around to compare the rates and terms of different lenders, continuously calculate the break-even point because it will be different based on the interest rate, term and closing costs associated with each mortgage.
What Is The Refinance Break-Even Rule Of Thumb?
In a refinance where the goal is strictly about saving money on the mortgage payment, the important thing to consider is how long you’ll be in the home or in that mortgage. If you plan to move or refinance again before you break even, it’s probably not worth refinancing. On the other hand, if you plan to stay there beyond that point, you should do it.
While this rule is helpful, every situation is also different. You’ll need to make sure you prioritize your own financial goals when refinancing so that the benefits outweigh any potential costs.
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How To Calculate The Refinance Break-Even Point
Before moving forward with calculating the break-even point, you need to look at different refinancing options. However, you may not be at a point where you’re ready to have your credit pulled and apply just yet. If this is the case, you can still see if refinancing will help you save money. You’ll just want to use a mortgage refinance calculator.
The calculator will ask you for certain information, including why you want to refinance, how much you have left to pay on your mortgage and your existing home equity. You’ll estimate your credit and enter the ZIP code for your home. Sharing your ZIP code is helpful for two reasons: it will help estimate taxes and insurance, and it ensures you’ll talk to someone licensed in your state if you move forward. You’ll also be asked whether you’re a veteran or serving in the military so we know whether to consider Department of Veterans Affairs (VA) loan options.
The calculator will ask different questions depending on your reason for refinancing. If you want to lower your payment, it will ask about the current one. If you’re looking to take cash out, it will ask you how much. If you want to pay off your mortgage faster, it’ll ask you how much time you have left on your existing term.
Once you submit your answers, the calculator will show you a range of options and the closing costs associated with each. From there, you can take the following steps to help you determine whether refinancing your mortgage is a good fit for your needs. We’ll be taking you through how to calculate the break-even point when your goal is to lower your payment in the refinance first, but we’ll go over other situations a little later on.
1. Total The Refinancing Costs
The first thing people think of when refinancing is how it will impact their monthly payment, but there are other costs associated with refinancing.. In most cases, you’ll have to cover closing costs and additional fees before you can refinance.
Your closing costs will be defined in a loan estimate that your lender provides you. From here, you can compare lenders and determine whether refinancing with any of them is a good option. Here’s a list of common closing costs you can expect to pay for when refinancing:
- Origination fee: The origination fee covers the lender’s costs for processing and underwriting the loan. That’s often how they make their profit on individual loans. This is typically 0.5% – 1% of the loan amount.
- Application fee/deposit: Some lenders may charge a separate application fee when they collect all the documentation needed for your loan and start the setup. Others make this fee a deposit that can go toward other closing costs after being taken up front.
- Appraisal: Because your home serves as collateral for the loan, your lender will need to know that the home is fit to be lived in and that they’re not giving you more than the home is worth. In a refinance, sometimes lenders have alternative methods of home valuation and it’s not necessary to do a full appraisal. However, you can’t count on this. This is typically anywhere between $400 – $600 but can vary based on where you live and the size of the home.
- Escrow charges: Escrow accounts allow you to split up the cost of homeowners insurance and property tax over the course of the year. When you refinance, you may need to open a new escrow account and your lender may charge you fees to do so.
- Title costs: A lender’s title policy covers the lender in the event there is a future claim to ownership of your house that prevails and you have to move out. Because the terms of the loan are changing, you’ll have to purchase a new one each time you refinance.
- Flood certification: Your lender will make sure that flood maps are updated and that you have appropriate flood insurance coverage if any is necessary.
- Tax service: In a refinance situation, you likely already know what your property taxes are. The purpose of this is to let your lender know if you miss a tax payment when you don’t have an escrow account.
- Settlement agent costs: This is the cost for someone to come out and conduct the closing. In some states, this can be someone with notary credentials. In others, an attorney is required to conduct the closing and it can cost more.
- Credit check fee: Lenders may charge you a fee when pulling your credit report.
Most lenders also offer what’s referred to as a no-closing-cost refinance. In a no-closing-cost refinance, you’re paying for the closing costs over the life of the loan rather than paying them at closing. The lender gives you a credit meant to pay for your closing costs in exchange for a higher rate than you would have if you paid your closing costs upfront.
2. Calculate The Monthly Payment Savings
The next step is to figure out how much you could save each month on your mortgage payment. To do this, take a look at the amount of your principal and interest payment on your current mortgage statement (before taxes and insurance).
Next, subtract what your principal and interest payment would be according to the loan estimate for your new loan. The amount you come up with is your monthly savings. You can also take a look at how much you’re saving in interest and take that into consideration as well.
3. Determine The Break-Even Point
To determine the break-even point, you divide your closing costs by the amount you save every month. The result is the amount of time it would take you to breakeven on the deal.
As an example, let’s say you save $50 per month by refinancing, but the loan comes with $5,000 in closing costs. It would take you 100 months, or a little over 8 years to break even.
If you stay in your house beyond the break-even point, you save on the loan. This assumes you don’t refinance again in which case you’ll have to start over with the calculations.
How To Calculate The Break-Even Point For A Cash-Out Refinance
A cash-out refinance involves converting some portion of the existing equity in your home into cash. For example, you might take cash out to do a home improvement or consolidate debt. This differs from a traditional rate/term refinance in that you’re not giving up any of the existing equity in a rate/term refinance. Rather, you do a rate/term refinance to lower your payment or change your term.
Since you’re borrowing against the equity in your home, the break-even point calculation will be different than it is for a simple mortgage refinance. The exact calculation is going to depend on the purpose of the refinance.
If you are doing a refinance for a home improvement and taking cash out, a big portion of your break-even calculation is going to come down to how much more you might have to pay for the loan, but also how much it will cost to do the improvement as compared to how much you expect to get back in added value when you sell the house after refinancing.
One way to evaluate whether refinancing for an improvement makes sense is to pay to consult an appraiser. This could help you understand what you’re getting into and whether it makes sense.
If you’re doing a cash-out refinance for consolidating debt, the important thing to consider is how much you’re saving on interest and how long it would take to pay off the same amount of debt at that interest rate if you didn’t do the consolidation.
Consolidate debt with a cash-out refinance.
Your home equity could help you save money.
FAQs About The Refinance Break-Even Rule
Now that we've gone over the basics, let's go over a couple of common questions.
Why does knowing your refinance break-even point matter?
Anytime you refinance your home loan, you’re taking out a new mortgage and you’ll have to pay the fees associated with creating that new mortgage. The last thing you want to do is end up paying more in closing costs and fees than you’ll save.
Knowing your break-even point will help you make smart financial decisions.
What other factors should I consider before refinancing?
Before refinancing, there are other factors you should take into consideration before deciding to (or not to) do so.
- How long is the new term? If it’s longer than your current term, you may end up paying more in interest. It’s something to consider.
- If you’re having to put cash in during the refinance to gain more equity and get a lower rate, you might consider all of the other possible alternatives of what you can do with the cash to make sure you’re getting what you want.
Always consider the refinance possibility in light of your other financial and life goals. Any major decision regarding your finances should be undertaken with an eye toward your full financial profile.
How long should it take for me to reach the break-even point?
The exact length of time that it will take for you to reach the break-even point depends on your type of refinance, the interest rate the lender charges you and the loan’s term. However, it’s common for people to break even within 2 – 3 years.
Can I refinance even if the break-even point is far out?
Yes. Ultimately, the decision to refinance or not is yours to make. If you plan on staying in your home for many years to come, refinancing may be a good idea even if you won’t reach the break-even point for 10 years.
When should I consider waiting to refinance my mortgage?
If the closing costs are high or the interest rate on your new loan would cost you more than you’re paying on your current mortgage, waiting to refinance may be a better option. It all comes down to your personal situation. Look at the loans you’re offered and consider how each payment would impact your finances and your goals.
The Bottom Line: Find Your Refinance Break-Even Point
The break-even point is very important to understand if you’re looking to refinance. If you’re using it to lower your payment or to consolidate debt, it’s the point at which you save money if you accept the loan. If you’re looking to take cash out, it’s important to understand how much the potential improvement could bring you in a sale, so the calculation is a bit different.
Beyond understanding the break-even point, it’s also important to think about your broader financial picture. Are you lowering your monthly payment at the expense of paying more interest? How does this fit in with your other financial goals?
Ready to refinance your home loan? Get started online and explore your refinance options.
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