Homeowners

Homeowners, Here’s How to Calculate the Mortgage Refinance Break-even Point

With prices remaining stubbornly high for just about everything, many are looking for opportunities to save money.

For some, this means cutting back on things like going to restaurants or other entertainment. Others are shopping more carefully at the grocery store and canceling subscriptions they no longer use. And some homeowners are exploring whether they could save money by refinancing their mortgages.

Lower mortgage interest rates may present a money-saving opportunity for some homeowners who bought their home when rates were higher. However, refinancing comes with various closing costs. That’s why it’s important to calculate your break-even point. This is when you will save more money by refinancing your loan when factoring in those closing expenses.

The average 30-year fixed-rate mortgage interest rate has dropped from over 7% in mid-January to the low 6.2% range in November, according to Freddie Mac data.

By refinancing into a new mortgage with a lower interest rate, homeowners may be able to lower their monthly mortgage payment. This is how to figure out whether it makes financial sense to do so.

Perform a break-even analysis before refinancing your mortgage

The decision to refinance a mortgage isn’t a slam dunk even in a falling interest rate environment. That’s because there are closing costs associated with refinancing that must be factored into the decision. Refinance closing costs generally range from 3% to 6% of the loan balance.

These refinancing costs typically include loan origination, application, appraisal, attorney, and underwriting fees, as well as title services and recording costs.

Plus, you want to ensure you’ll be in the home long enough to recoup those costs.

“Your savings in monthly payments need to be enough to offset the closing costs associated with the refinance,” said Larry Steinway, a regional manager and vice president of mortgage lending for New American Funding in Skokie, Ill.

To calculate your refinance break-even point, find out how much you will pay in closing costs. Then see how much you will save every month on your mortgage payments with a lower interest rate. You do this by subtracting your projected new monthly payment from your current one.

Then divide your total closing costs by how much you’ll save a month. This helps you figure out how many months you will need to stay in the home before you begin saving money.

Let’s say you have an outstanding mortgage balance of $200,000 and closing costs are $10,000.

The refinance will lower your interest rate by 1.5 percentage points, saving you $250 per month. In this scenario, your break-even point is 40 months to recoup the cost of refinancing (10,000 divided by 250 = 40).

After 40 months, or 3.5 years in this scenario, you’ll enjoy a net cost savings every month.

“The longer you stay in the home, the more money you’ll save over the long term,” said Steinway.

What else homeowners should consider before refinancing their mortgages

Once you’ve determined your break-even point, really think about how long you plan to remain in your home. If you think there’s a good chance you’ll move before you reach the break-even point, then refinancing might not be a good decision.

But if you plan to stay in the home for the long term and mortgage rates really come down, your savings could be substantial. If you remain in the home for the entire 30-year term, you could save quite a bit of cash.

Also consider that refinancing will reset the clock on your mortgage.

For example, if you have been making payments on a 30-year mortgage for 15 years, you’re halfway to owning your home free and clear. If you refinance to a new 30-year mortgage, you’ll be starting all over again.

Instead, you could opt for a shorter loan term on your new mortgage, such as a 15-year or 20-year term. This way you’re not increasing the length of your loan.

Refinancing your mortgage into an adjustable-rate mortgage

Another potential money-saving strategy is refinancing from a fixed-rate mortgage to an adjustable-rate mortgage (or ARM).

ARMs generally feature lower initial interest rates than fixed-rate mortgages. But the rate adjusts after a certain number of years to reflect prevailing market rates up to a certain cap.

“Seven-year ARMs are popular right now because many people believe that interest rates will continue to drop,” said Steinway.

The initial ARM interest rate could save you money now if it’s lower than your current mortgage rate. If interest rates are lower when it resets, you’ll save even more. And if they’re higher, you may be able to refinance into another ARM.

While refinancing your mortgage could save you money each month, it’s important to do the math and determine your break-even point. This is the best way to decide if refinancing is a wise decision for you.

Larry Steinway NMLS # 223579