With the Federal Reserve lowering interest rates by 0.5% in March 2020, mortgage refinancing has been high. The lower interest rates are meant to help boost the economy during the COVID-19 pandemic. And although very attractive, you need to take a step back and understand what refinancing means to you before shopping for the best deal.
What is the Breakeven Point?
Your breakeven point is the amount of time it will take to start saving money after refinancing your home. That is, the point at which your savings are more than the costs of the new loan. You may be surprised that it might take years to achieve a breakeven point.
Before getting a refinancing, you need to start by considering your goals. Do you want to reduce your mortgage term, lower your monthly payments, get cash for a big purchase, or take advantage of record-low interest rates? Refinancing is also an excellent way to reduce debt and finish off mortgage payments faster. And the costs to see whether you are okay with your breakeven point.
Factors That Determine Your Break-Even Point
Costs to Refinance
Refinancing your home comes with all the loan expenses of the old one, including a Principal Mortgage Insurance (PMI) if you have less than 20% of your home’s equity. Typically, the closing costs for a refinance take up between 2-6% of the loan principal. These costs vary for different loans and from one lender to another.
The other costs include bank fees like application and origination fees, discount points, title insurance, search costs, taxes, insurance, and third party charges, such as an attorney’s fees and an appraisal. These costs appear on your Closing Disclosure and the Loan Estimate. Be sure to add them up to find the total cost. They will determine whether you are okay with the breakeven point.
Savings from Refinancing
Refinancing your mortgage is a wise and effective way to save money and build equity quicker. Knowing how much you will be saving in terms of your monthly payment is an integral part of the calculation for the breakeven point.
You can get your monthly savings amount by subtracting your new monthly payment from your old payment. What you do with the savings is entirely on you.
For you to reap the benefits of refinancing, you need to consider time in many aspects. For instance, many lenders will offer you the fastest breakeven point, but it is not by default the most profitable for you.
Think about how long you plan to stay in that house before moving and reselling the property. If you have no plans to move out of the house soon, then a quick breakeven point will not benefit you. Go for an option that saves you more money during your loan repayment period. On the other hand, if you intend to move out in a couple of years, pick an option that will help you break even faster, reduce the interest costs, and help you complete your mortgage faster. You will also need to consider:
- The original mortgage amount
- The amount you have already paid down
- Your original interest rate whether it was a fixed-rate mortgage or an adjustable-rate mortgage
- The amount being financed
- The loan’s original term and how long you have had the loan
All these factors determine the length of a breakeven point that is most profitable to you.
How to Calculate the Breakeven Point for Your Mortgage Refinancing
Having all the factors in mind, the calculation of the breakeven point is quite straight-forward. You need to divide the total loan expenses by the expected monthly savings.The written formula should look like this; Time Period=Costs/ Monthly Savings.
Assuming the refinancing fees total to $2,000 and the savings is $100 per month. By dividing $200 by $100, you will get 20. Meaning it will take 20 months to equate the savings to the costs and hence, reach your breakeven point. After this point, you can enjoy lower interest rates for the rest of your mortgage term.
But do not celebrate just yet, your savings are also altered if you extend the loan term. That is, if your refinanced loan term significantly exceeds the number of months that had remained on your original loan, you may need to rethink. The extension could accrue more interest in the long run, and you will end up paying more interest.
Remember that you can save big bucks beyond the breakeven point by refinancing your loan to a shorter term. This way, you get to save more in total interest even though your monthly payments will rise.
Now that you know your breakeven point remember to look at your financial situation and have your goals in mind before refinancing. Remember also to shop for your refinancing the same way you did with your mortgage.