NOTE: Refinancing can be challenging due to the coronavirus outbreak. Lenders face high credit demand and staffing problems. If you are unable to pay your current home loan, see our mortgage guide. For the latest information on how to deal with financial stress during this emergency, see NerdWallet’s Financial Guide to COVID-19.
Before you refinance your mortgage, you should find out when you would break even. Your breakeven point comes when you start saving money – in other words, when your accumulated savings exceed the cost of the new loan.
How long does it take for the refinancing costs to amortize?
Without knowing when the monthly savings will exceed the cost of refinancing, you may be shocked to learn that it can take years to break even.
You may want to reduce your monthly payment or shorten the term of the loan and pay less interest over the term of the loan.
Of course, there could be other reasons to refinance your home loan – for example, to develop your home equity by withdrawing cash or to cut your mortgage insurance premiums. All you have to do is consider your costs and goals, and make sure you know how long it will take to break even.
Is there a rule of thumb for refinancing?
There is no rule of thumb when it comes to “should I refinance?” Go. Every situation is different; You cannot rely on a one-size-fits-all rule. Just make sure the financial benefits justify the cost.
Collect all of the costs of refinancing your mortgage
Once you have “How long?” It’s time to ask, “How much?” In general, the cost of a refinance is fees and closing costs, including:
Bank fees: such as origination or application fees and any discount points that the bank may charge.
Title costs: Including title search and insurance.
Third party costs: Such as an appraisal or legal fees, or the cost of a credit report ordered by the lender.
Each lender you shop will be given a loan estimate form listing all the costs you will have to pay when applying. It’s always a good idea to apply to more than one lender to make sure you are getting the best deal.
Calculate the break-even point for a mortgage refinance
Now is the time to calculate how many months it will take to break even. To do this, divide the total cost of borrowing by the monthly savings.
For example, let’s say the refinancing fees are $ 3,000 and you save $ 100 per month. Divide $ 3,000 by $ 100. The answer is 30. That means it will take 30 months for the refinancing costs to amortize. There is your breakeven point.
Anything beyond that 30 month breakeven point translates into cost savings. Yes, money in your pocket!
However, there is one small print associated with this savings celebration: your savings may vary as you extend the term of the loan.
If the number of months you pay for your new refinance significantly exceeds the number of payments left on your original loan, you may be paying a boatload with additional interest. You need to decide if the additional cost is worth it.
Big savings that break even
If you want to repay your home loan in a few years with a shorter term refinancing, your savings can multiply past the break-even point. Refinancing on a shorter term is not about a lower monthly payment, but rather about saving a lot of money on the total interest.
For example, if you’ve been paying a 30 year mortgage for five years, you have 25 years on the loan. If you are refinancing at a lower interest rate and your income has increased since you received the mortgage five years ago, you may be able to afford refinance on a 15 year loan or 20 year mortgage. The monthly payment could go up, but you could save thousands of dollars in interest in the long run.
Take other factors into account
So a refi offers more than just a breakeven point. Further questions to be answered:
How long did you have the loan?
How much did you pay?
Is this your “forever” or “for now” home?
The answers can have an impact on how long a break-even point makes sense.
And if you’re looking for more than just a calculation on the back of a napkin, this refinance calculator can show you your break-even point and total savings in no time.