What Is The Refinance Break Even Point?
Kevin Graham8-minute read
September 14, 2021
If you’re looking to make changes to your mortgage to take cash out for a home improvement or to consolidate debt or even to save money, you want to know how to figure out whether it makes sense to take on new mortgage terms at this time. One way to figure that out is to calculate the refinance break-even point.
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 before answering some common questions.
What Is The Refinance Break-Even Point?
The refinance break-even point can be defined as the point at which it starts making financial sense to refinance and take on the terms of a new mortgage. For those considering refinancing their mortgage, it’s crucially important to make sure that it makes financial sense to do so based upon whatever your goals are in changing the terms of your mortgage.
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 rate, term and closing costs associated with the mortgage.
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, but you may not be at a point where you’re ready to take this step of having your credit pulled and putting in an application before having some idea of whether refinancing will help you meet your goals. We encourage you to check out the Rocket Mortgage® mortgage refinance calculator.
The calculator will ask you for certain information, including what your goal is in the refinance, how much you have left to pay on your mortgage and your existing equity. You’ll estimate your credit and say where you live. 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 VA options.
You’ll also be asked different questions depending on your goal. If you want to lower your payment, we ask about the current one. If you’re looking to take cash out, how much? If you want to pay off your mortgage faster, how much time do you have left on your existing term?
Once you submit, the calculator will show you a range of options and, crucially for determining the break-even point, the closing costs associated with each. From there, you can take the following steps to help you determine whether any particular option is right for you. 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. There are closing costs and other fees.
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.
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. In addition to bank fees you might be charged in order to produce statements and other required documentation for you, here’s a list of common closing costs.
- 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 ready 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. It can vary based on where you live and the size of the home.
- Escrow charges: You’re often required to have an escrow account if you make a down payment of less than 20%, but even if you aren’t, people often choose to have them so that their homeowners insurance and property tax costs can be split up over the course of the year. You’ll be required to put in a certain number of months’ worth of insurance premiums and property taxes in order to fund the account. If you’re doing something like a streamline refinance with the same lender, they may be able to transfer the account between loans. Otherwise, you’ll get some of this money back when your original lender closes your escrow account and sends you a check.
- Title costs: I can guess what you’re thinking: “I paid for title costs when I originally bought the house and the title isn’t changing. Why would I pay them again?” 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. They’ll also conduct a title search. This checks to make sure there aren’t any new liens on the title since the last time you got a new mortgage. If you purchased an owner’s title policy to protect your interests in the face of future potential ownership claims, that remains in effect for as long as you own the house.
- 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. Sometimes this can be someone with notary credentials. In other states, an attorney is required to conduct the closing and it can cost more.
- Credit check fee: There is a cost associated with pulling your credit report.
2. Calculate The Monthly Payment Savings
The next step is to figure out how much you save each month on your monthly 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.
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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 breakeven, it’s probably not worth refinancing. On the other hand, if you do 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.
FAQs About The Refinance Break-Even Rule
Now that we've gone over the basics, let's go over a couple of common questions.
How do I calculate the break-even point on 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.
In a cash-out refinance, the break-even point 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.
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.
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.
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 do a debt consolidation, it’s the point at which you save money by doing the loan. If you’re looking to take cash out to do home improvements, 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?
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