What Is The Refinance Break-Even Point?

If you’re looking to refinance your mortgage to take cash out for a home improvement, consolidate debt or build your emergency fund, you may want to figure out whether it makes sense to take on a new mortgage loan. One way to make this determination is to calculate the break-even point for a refinance.

The break-even point for a mortgage refinance can be a useful metric to analyze whether it’s the right time to refinance your home loan.

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 original loan terms. You’ll want 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, mortgage refinancing may not be the best financial decision right now.

As you shop around comparing the rates and terms from different lenders, consider calculating the break-even point for each refinance option. The break-even point may vary based on the interest rate, loan term and closing costs associated with each mortgage.

What Does The Refinance Break-Even Rule Look Like?

If your refinance goal is to save money on your monthly 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 in the home beyond that point, you may want to consider refinancing.

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 additional costs.

Before moving forward with calculating the break-even point, you might want to look at different refinancing options. However, you may not be at a point where you’re ready to have your credit pulled to apply for the refinance. In this case, you can still see if refinancing will help you save money using a mortgage refinance calculator.

Let’s take a look at how to use the mortgage refinance calculator.

Enter Your Information

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 score 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 you know whether to consider VA loan options backed by the Department of Veterans Affairs (VA).

Identify Your Reason For Refinancing

The calculator will ask different questions depending on your reason for refinancing. If you want a lower monthly payment, it will ask about your current one. If you’re looking to take cash out, the calculator will ask you how much money you want to borrow. If you want to pay off your mortgage faster, it’ll ask you how much time you have left on your existing loan term.

Once you submit your answers, the calculator will show you a range of options and the closing costs associated with each.

After you’ve gotten familiar with the refinance calculator, you can take the following steps to help you determine whether refinancing your mortgage is right for you. Let’s go over how to calculate the break-even point if your goal with the refinance is to lower your mortgage payment. We’ll go over how to calculate the refinance break-even point for other situations later on.

1. Total The Refinancing Costs

While the first factor you might consider when refinancing is how it’ll affect your monthly payment, there are other costs associated with refinancing. In most cases, you’ll have to cover closing costs and additional fees when you close on the new loan or finance those costs into your total loan amount.

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 when refinancing:

• Origination fee: The origination fee covers the lender’s costs for processing and underwriting the loan. 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 upfront.
• Appraisal: Because your home serves as collateral for the new 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. A home appraisal can be anywhere from a few hundred to a few thousand dollars 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 taxes 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 insurance policy covers the lender if there’s 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.

Using A No-Closing-Cost Refinance

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. Financing your closing costs into your loan may affect your loan terms, so be sure to discuss your options with your lender to make sure it’s right for your financial situation.

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 payments on your current mortgage statement (before taxes and insurance, as they shouldn’t change in a refinance).

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, too.

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 break even on the deal.

Break-Even Point Example

Let’s say you save $50 per month by refinancing, but the new 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 end up saving money with the refinance. This assumes you don’t refinance again, in which case you’ll have to start over with the calculations.

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 fund a home improvement or consolidate debt. This differs from a traditional rate-and-term refinance because you’re not giving up any of the existing equity with a rate-and-term refi. Rather, you do a rate-and-term refinance to lower your interest rate or change your loan term.

Since you’re borrowing against the equity in your home with a cash-out refi, 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.

Refinancing For Home Improvements

If you’re refinancing 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. It’ll also depend on the total cost to do the improvement compared to the amount you can 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 to refinance.

Refinancing For Debt Consolidation

If you’re consolidating debt with a cash-out refi, the important thing to consider is how much you’re saving on interest over the life of the new loan. You might also want to think about how long it would take to pay off the same amount of debt at that interest rate if you didn’t do the consolidation.

Now that we've covered the basics, let's go over a couple of common questions about the break-even point for refinancing.

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. If you end up paying more in closing costs and fees than you’ll save by refinancing, it might not be worth it in the long run.

What other factors should I consider before refinancing?

You might want to consider the length of the new loan term. If it’s longer than your current term, you may end up paying more in interest. If you have to put cash in during the refinance to gain more equity and get a lower interest rate, you might also consider what else 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.

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 number of months it’ll take to pay off the new loan.

Can I refinance even if the break-even point is far out?

Yes. Ultimately, the decision to refinance 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 many 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 original 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.

If you’re refinancing to lower your monthly payment or consolidate debt, the break-even point is 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 home improvement could bring you in a sale, so the calculation is a bit different.

Ready to refinance your home loan? Get started online and explore your refinance options.