Calculating the Break-Even Point When Refinancing
By: Rosemary Rugnetta | May 9th, 2013
When refinancing a mortgage, there are many questions to consider in order to know whether the borrower is going to benefit from the transaction. One of these has to do with the break-even point and when it will occur. By calculating the break-even point when refinancing, a borrower can then decide whether it makes sense to go ahead.
The break-even point when refinancing is the period of time when the costs associated with the refinance have been covered by the interest savings. The larger the difference between the mortgage rate on the existing loan and the new interest rate, the shorter the break-even period will be. However, the more it costs to obtain the refinance, the longer the break-even period will be.
To determine this is not difficult. The simplest and most often used way of doing so is to take the current monthly mortgage payment and subtract the new monthly mortgage payment which equals the monthly savings that will be the result of refinancing. Now divide the costs of all fees for the refinance by the monthly savings which will equal the amount of months it will take to recover the cost of refinancing.
According to the Federal Reserve, another more accurate way to do this is to first calculate your monthly savings. Then subtract your tax rate from 1 (eg. 1 – .28 = .72). Multiply the monthly savings by your after tax rate which equals the after tax savings. Now divide the costs of the refinance by the monthly after tax savings which will equal the number of months to recover the costs of the refinance.
Another fact to consider when calculating the break-even point is the result of the lower rate on the new loan and the balance at the break-even point. With a lower mortgage rate, more principal will be paid monthly. After calculating the break-even point, such as 12 months, look at the balance of the old loan in 12 months and the balance of the new loan. If the principal balance is less on the new loan at 12 months, then there is also a net gain at the break-even point.
Many borrowers consider the break-even point especially if they are not going to be living in the home for a long period of time. Most often, the costs associated with refinancing is not worth it to the homeowner who will be moving shortly. However, taking the time to figure out the true break-even point as well as any additional savings may change that outlook.
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