Breaking Even on Your Refinance

I’m often asked "how many months will I break even on a refi?"    This is actually something very easy to figure out and worthwhile for anyone who’s considering restructuring their mortgage.  In a nutshell, you are taking the non-reoccurring closing costs and dividing the difference between your current mortgage payment and your proposed mortgage payment.   

To determine your closing costs, you are going to consider all fees except for your reserve account and prepaids (taxes, insurance and prorated interest).  This is what you are paying for your interest rate to refinance the mortgage. Your prepaids should not be factored into your closing costs because your existing balance of your prepaids/reserves from your current lender will be refunded to a few weeks after closing the new mortgage.   If you don’t wish to have your new reserve account financed into the new mortgage, you can bring cash to the closing table (a majority roll this cost into the new mortgage; but it’s totally up to you).  You can also opt to waive your reserve account all together if you meet the criteria, just know that there is a cost to doing this.

Next factor the difference between your current mortgage payment and your proposed mortgage payment.  Ideally, you should look at just principal, interest and mortgage insurance (excluding taxes and insurance).  Divide this figure into the closing costs and you have how many month’s it takes to break even on the refinance.

Here’s an example from a recent Good Faith Estimate I recently provided a client:

• Current Payment: $1740 less the Proposed Payment: $1550 equals a monthly savings of $190.
• Closing costs (excluding taxes, insurance and prepaid interest (Sections 900 – 1000 on the GFE) are $2390.   2390 divided by 190 equals 12.58 months to break even on the cost of the refinance.

If the borrower is staying in their home for over 13 months, the refinance makes sense.   They are "breaking even" on the cost of the refinance.   If the homeowner was only improving their monthly payment by $50 a month, it would take about 4 years to break even.   Does it still make sense?  This really depends on the individual home owner.  If they’re not likely to move and if the rate is low enough to where they’re not likely to refi, perhaps it still does.  This is just a tool to help consumers weigh the cost of refinancing.   Different pricing, such as with or without points or without closing costs, will also impact how soon someone will "break even" on their refi.   Watch for a follow up post on that!