Should You Refinance? How to Calculate Your Break-Even Point
Lowering your interest rate sounds great, but refinancing isn't free. We explain how to calculate your 'break-even point' to ensure the upfront costs don't outweigh your monthly savings.
When mortgage rates drop, the headlines scream "Refinance Now!" But for individual homeowners, the decision is purely mathematical, not emotional. Refinancing involves taking out a completely new loan to pay off your existing one, and that comes with closing costs.
The Golden Rule: The Break-Even Point
To determine if refinancing makes sense, you must calculate how long it will take for your monthly savings to pay back the upfront costs.
The Formula:
Total Closing Costs / Monthly Savings = Months to Break Even.
Example:
- New Loan Savings: $200 per month.
- Closing Costs: $4,000.
- Calculation: $4,000 / $200 = 20 months.
Verdict:
If you plan to stay in the home for more than 20 months, refinancing is a win. If you plan to move in a year, you will lose money.
Reasons to Refinance (Beyond Rate)
Shortening the Term:
Switching from a 30-year to a 15-year mortgage. Your monthly payment might go up slightly, but you will save tens of thousands in interest over the life of the loan.
Eliminating PMI:
If your home value has risen and you now have 20% equity, refinancing can remove costly Private Mortgage Insurance that might otherwise be stuck on your loan (especially for FHA loans).
Switching from ARM to Fixed:
If you have an Adjustable Rate Mortgage (ARM) and rates are rising, locking in a fixed rate provides long-term security.
The Cost of Waiting
Trying to time the absolute "bottom" of the market is risky. If rates are significantly lower than your current mortgage (typically 0.75% to 1% lower), and you plan to stay put, locking in savings now is often better than gambling on future rate cuts.