How do you calculate the break-even period?

Editor Loan Lenders- Loan advices August 30, 2016

How do you calculate the break-even period?

 

Use the step-by-step worksheet below to give you a ballpark estimate of the time it will take to recover your refinancing costs before you benefit from a lower mortgage rate. The example assumes a $200,000, 30-year fixed-rate mortgage at 5% and a current loan at 6%. The fees for the new loan are $2,500, paid in cash at closing.

 

	Example	Your numbers
Your current monthly mortgage payment	$1,199
Subtract your new monthly payment	– $1,073
This equals your monthly savings	$ 126
Subract your tax rate from 1 (e.g. 1 – 0.28 = 0.72)	0.72
Multiply your monthly savings (#3) by your after-tax rate (#4)	126 x 0.72
This equals your after-tax savings	$ 91
Total of your new loan’s fees and closing costs	$2,500
Divide total costs by your monthly after-tax savings (from #6)	$2,500 / 91
This is the number of months it will take you to recover your refinancing costs	27 months

Tip: Calculate the financial benefit of refinancing in one, two, or three years. Does the benefit compare with your plans for staying in your home?

 

If you plan to stay in the house until you pay off the mortgage, you may also want to look at the total interest you will pay under both the old and new loans.

You may also want to compare the equity build-up in both loans. If you have had your current loan for a while, more of your payment goes to principal, helping you build equity. If your new loan has a term that is longer than the remaining term on your existing mortgage, less of the early payments will go to principal, slowing down the equity build-up in your home.