How to Figure Out the Break-Even Point

The break even point is a guideline used by home owners as a way to determine whether or not refinancing a mortgage is a good idea. The break even point is the number of months that it will take for the cost of refinancing to equal the savings that a new mortgage's terms provide. Determining the break even point requires plugging specific variables into a simple mathematical equation.

The Two Sides of the Equation

The cost side of the equation includes the amount of money spent in closing costs, processing fees, and any other upfront payments, including appraisal fees, which the borrower was required to make to the lender at the time of refinance. It is a good idea to request a good faith estimate from lenders to determine the actual cost of the loan you are applying for.

The savings side of the equation depends on the amount of money that the borrower owes to the lender each month. This amount is a reflection of the total amount of money that the loan is for, the interest rate, and the term of the loan. Longer termed loans will have lower monthly payments than shorter termed loans of the same amount. It is important to consider mortgage insurance premiums because they can increase with refinances.

The Equation

The specific equation to determine the break even point is simple. The simple equation requires the borrower to figure out their total monthly savings. Monthly costs are made up of principle and interest. Monthly savings can be found by subtracting the total of monthly principle and interest payments with the new mortgage from the total of monthly principle and interest payments with the old mortgage. Once monthly savings are determined, divide this number into the total cost of refinancing. The resulting number is the number of costs that it will take for the borrower to break even.

More complicated equations involve adjusting the calculations for fixed rate mortgages, adjustable rate mortgages, and other interest rate varieties. In order to accommodate these variations, simply change the value of monthly savings to reflect the changing interest rates. 

Adding Points

A borrower will commonly add points to reduce the rate of their loan. The more points you pay, the lower the rate is reduced. The cost of the additional cost of points should be weighed carefully.

If a borrower is attempting to determine whether or not to pay points on a mortgage, they can manipulate the break even point equation even more. Mortgage points represent 1% of the total loan amount and can be easily added to the closing costs to determine the true cost of adding or subtracting points. Mortgage points raise the cost side of the break even point equation and also raise the amount that a borrower will save per month. 

If a borrower prefers to use the internet, there are many sites that offer break even calculators. Home owners can simply plug in numbers and have the entire calculation done electronically. The websites can be found with the Federal Reserve and other government institutions.


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