What Is a Break-Even Point? (and Why You Need to Know Yours When Refinancing)
Interest rates have consistently been at historic lows throughout the coronavirus pandemic, and, as a result, many people have rushed to refinance their mortgages. However, the truth is, that refinancing right now doesn’t make financial sense for everyone. If you’re thinking of refinancing, finding your break-even point is one way to figure out if you’re a good candidate for a new loan.
With that in mind, keep reading. We’ll tell you more about what a break-even point is, why it matters when you’re refinancing, and how to do the math to find your own. Armed with this knowledge, you should have a much better idea of whether or not refinancing in the current interest rate environment could be the right move for you.
What is a break-even point?
Before we can get into the specifics about break-even points, it’s important to clarify some points about how refinancing works. In essence, the refinancing process involves taking out a new loan to pay off your existing mortgage. Similar to when you first took out your home loan, this process comes with an upfront cost.
That’s where the break-even point comes into play. As the name suggests, a break-even point is the time it takes for you to get back the amount of money you invested in your refinance. It is from that point afterward that you will truly begin to see savings from refinancing your mortgage.
Obviously, this point will be different for everyone who is trying to refinance, depending on the total amount of your closing costs and the total amount of savings that you’ll see from your new loan. That said, doing this equation can help you to decide whether or not to refinance at the moment.
Why your break-even point matters when refinancing
The reasoning behind why it’s important to find your break-even point is simple. Truthfully, the decision to refinance is not a small one. The upfront cost of refinancing can often end up being thousands of dollars. With that in mind, before you do it, it’s absolutely crucial to make sure that putting out that amount of money will benefit you in the end.
Above all else, refinancing helps give you some context to weigh the decision. By showing you how long it will take you to break even on the upfront cost of refinancing, your break-even point can help you determine whether or not you’ll be in the home long enough to reap the benefits of switching to a new loan.
While there’s no hard-and-fast rule on how long it should take to break even in order for refinancing to be a good idea, one study found that it takes an average of 4 years for homeowners to break even on the upfront cost of taking out a new loan. You may want to use that figure as a rule of thumb as you do your own calculation.
How to find your own break-even point
Luckily, finding your own break-even point is fairly simple. All you need to do is divide the total upfront cost of the loan (which you can get by talking to a lender) by your projected monthly savings from refinancing. After that, the result you’re given will signify the number of months that it will take you to break even on the cost of taking out a new loan.
For example, let’s say that you stand to save $75 a month by refinancing at a lower interest rate. In this scenario, let’s also assume that it costs $4,500 to refinance into the new loan. In that case, the equation for finding your break-even point would look like this:
$4,500 / $75 = 60 months to break even on refinancing
60 / 12 = 5 years to break even on refinancing
Ultimately, in order to figure out whether refinancing makes sense, you need to think about your plans for the future. Do you intend to stay in the home long enough to break even on the cost of the refinance and to start to see some true savings?
If so, refinancing might be worth it. However, if not, it may be a better financial decision to simply make extra payments on your existing loan whenever possible.
The bottom line
At the end of the day, making the decision to refinance your mortgage is a big deal. While calculating a break-even point can help steer the decision-making, it should not serve as the be-all-and-end-all of your thought process.
If you truly want personalized guidance on whether or not refinancing is the right decision for you, your best bet is to talk to an experienced lender. He or she will be able to look at the specifics of your financial situation in order to help steer you in the right direction.