What’s the Break-Even Point in Refinancing?
Between the current, exceptionally low interest rates and robust housing market through much of the country, refinancing your home mortgage this year has never been more appealing – for a variety of reasons; probably the most notable being the economic uncertainty as a result of the pandemic. Whether for extra savings on the monthly payment, or to take cash out of the equity to be proactive, refinancing can be a savvy financial decision for many homeowners.
While it’s easy to be enthusiastic about the potential savings on your monthly mortgage payment, or a hefty payout from your equity, you don’t want to forget to factor in the closing costs. This is how you’ll determine the break-even point, which measures the amount of time it will take to recoup the fees to refinance based on your savings. The sooner you make the break-even, the more cost-effective the transaction will be for you.
Calculating when that point is, and whether the decision to refinance is worthwhile, all depends on your individual financial goals and the type of refi program you’re considering.
Common Mortgage Refinance Types
Rate and Term | The most common reason to refinance is to take advantage of lower rates, thus reducing your monthly payment. This is referred to as a rate and term program. It’s also a good way to save proactively if your original loan is an ARM, or adjustable rate mortgage, and you want to change to a fixed-rate. This may also make it possible to eliminate your private mortgage insurance (PMI).
Term Reduction | This refinance program allows you to reduce your term to 10-, 15-, or 20-year mortgages. The savings may depend on how long you have left on your original 30-year loan, and how much more you can afford to pay each month.
Cash-Out Refinance | Taking advantage of the increased equity in the home is a popular objective with a cash-out refinance. You can replace your current mortgage and take the difference in the current value from your new loan in cash. Figuring the break-even for a cash-out is a little different.
Calculating the Break-Even Point
The simplest way to figure the break-even point on a refinance is to determine your monthly savings and divide it into the closing costs. In other words: Months to break-even point = closing costs / monthly savings. What do closing costs consist of? They vary from lender to lender as well as loan type, and they typically fall between 3% and 6% of the principle. These fees may include:
- Appraisal cost
- Credit report fee
- Title fees
- Tax service fees
- Origination fee
For example, we’ll assume the closing costs and fees on the new mortgage total $3,000. With the new lower interest rates, there’s a savings of $200 each month. When we divide 3,000 by 200, we get 15, which means you’ll break even in 15 months. After that point, the $200 savings goes straight to your pocket, figuratively. You can also roll it into the principle to pay off sooner and save thousands more in interest.
When refinancing for cash-out, calculating your break-even point is a little more nuanced because you’ve reduced your equity or chances are, you’re not seeing the savings in your monthly payment. However, if you’re taking the cash to pay down high interest credit card debt there will be cumulative savings. Or if you’re using it for home improvements, you’re potentially increasing the value of the property for a future sale. There is no calculable break-even when you reduce your term, but you’re saving on the overall interest of the loan, rather than on the monthly payment.
What’s a Good Break-Even?
Ultimately, the answer to this question begs more questions. What type of refinance is best for your situation? How much do you want to save short term? Long term? Most importantly, how long do you plan to stay in your home? If you don’t plan to move for a long while, then recouping your closing costs in two or three years feels very manageable. If you plan to move sooner, but want to put some money into the house to increase its sale-ability, as mentioned above, the break-even can be mitigated.
We at Titan Mutual Lending Inc. (Titan Mutual Lending Inc.), know that everyone’s financial goals and break-even points are different. While online calculators are handy, everyone’s mortgage and goals are different so we’re happy to crunch your personal numbers to let you know if the break-even point makes refinancing a good decision. Contact us today!