A mortgage refinance is not always a money-saving proposition. It should be so. To know if a refi is a smart financial move, you’ll need to do a little but simple math, and consider more than just interest rates.
Here’s how to calculate your break-even point on a mortgage refinance.
See today’s best cashback rates.
What is the break-even point in a mortgage refinance?
The break-even point of a mortgage refinance is that where i The monthly savings on the down payment equals the cost of refinancing. You generally wouldn’t want to move out of your home before you’ve repaid the cost of the new loan you got.
Here is the formula:
Total cost of repayment / Monthly savings = Number of months to earn point balance
Freddie Mac, one of the state-sponsored companies that provide money to the mortgage market, estimates that refinancing a loan costs 3% to 6% of the principal.
Using 3% closing costs as an example, let’s assume a $200,000 loan balance with 20 years remaining on the original term. The current interest rate is 7%, and the borrower repays the money at 5% over the same period of 20 years.
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The principal payment and interest each month comes to $1,551.00 at 7%.
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A 5% financing return would have monthly P&I payments of $1,320.
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The monthly savings equals $231.
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With a 3% closing cost of $6,000, it will take about 26 months to break even.
The figure: 6000 / 231 = 25.97
Read more: Types of refinancing options
There is a long list of reimbursable costs
If it’s been a while since you closed your loan, you may have forgotten (maybe not forgotten) a number of loan and closing costs, which can include:
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Loan origination costs and underwriting costs
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Application fees
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Discount points (optional)
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Title insurance and title search fees
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Measurement
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Recording fees
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Credit report fees
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Escrow Services
If you include your closing costs in your new loan, or the lender offers you a “non-closing cost refund,” you will likely have a higher interest rate and/or additional debt financing. That will affect your balance point.
Read more: How much does it cost to refinance a mortgage?
Consider the term of the loan and your long-term plans
You can relax even faster by extending your time. For example, in the above scenario, refinancing with a new term of 30 years, rather than 20 years, lowers your payment even more, and your break point is only 13 months.
Cons: You pay a lot more interest over the life of the loan because of the extra 10 years imposed.
However, if you plan to move to another home sometime after the break-even point and before the end of the 30-year term, you can make the numbers work for you.
Not all refinances have the same break-even point
As mentioned above, financing your closing costs will increase your break-even point. Another example: cash-out refinance. You withdraw some of your home equity and add it to your new loan, so your monthly payment is greater than the refinance.
Read more: Advantages and disadvantages of cashback
The tipping point for repurchases: Frequently Asked Questions
What is the best point of rest to recover?
The best break-even point for a mortgage refinance depends on how long you intend to stay in the home. If you are likely to stay there for three years or more, then an 18 to 24 month layover may work. It is best to do the math mentioned above to consider your options.
What is the 2% cashback rule?
The 2% rule says that you should refinance when you can get a 2% reduction in your interest rate, say, from 7% to 5%. However, like most ‘rules of thumb’, the answer is very simple. A lot of deciding when to refinance depends on how big the loan balance is and how long you intend to stay in the home. Borrowers today may benefit from interest rate cuts of half a point or more. Another decision is guided by statistics and circumstances.
Is it worth refinancing from 7% to 6%?
Can be. A one-point improvement in your mortgage interest rate can lower your monthly payments significantly, especially with larger loan balances. Just resist the temptation to extend your loan term beyond the current repayment period. That adds more interest and debt to the new loan.
What is the 80/20 rule for refinancing?
The 80/20 rule is a common use of equity benchmark lenders. Most lenders will let you borrow up to 80% of your home’s value, meaning you have 20% equity in your home.
