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Nerdy takeaways
- A mortgage refinance can save you money, but you have to pay upfront fees and costs first.
- To calculate how many months to break even: Add up total costs. Then, divide that by your monthly savings.
- It can take a few years to break even after refinancing. If you plan to move soon, consider if it’s worth it.
Before you refinance your mortgage, figure out when you would break even. Your break-even point occurs when you begin saving money — in other words, when your accumulated savings exceed the costs of the new loan.
How long does it take to recoup refinance costs?
When you lock in a lower interest rate, a mortgage refinance can help you save money — but those savings are offset by upfront costs. Similar to getting a purchase mortgage, you’ll have to pay closing costs and fees when you refinance.
Did you know...
The average cost of a mortgage refinance is $5,000, according to a 2022 report from Freddie Mac. Common reasons to refinance include:
- Securing a lower interest rate to reduce your monthly payment.
- Shortening the repayment term to pay off your loan faster.
- Tapping into home equity (a cash-out refinance).
- Getting rid of Federal Housing Administration (FHA) mortgage insurance.
- Switching from an adjustable- to a fixed-rate loan.
Before you refinance your mortgage, figure out when you would break even.
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First: Add up all the costs of refinancing
The first step to calculating your break-even point is determining how much you’ll spend on fees and refinance closing costs.
When you apply to refinance, each lender will give you a Loan Estimate form detailing all the costs you’ll have to pay. You can use these numbers to estimate your total loan cost.
Refinance closing costs include:
- Lender fees: Such as origination or application fees that the lender may charge, as well as any discount points that you may choose to buy.
- Title costs: Including a title search and insurance.
- Third-party costs: Such as an appraisal or attorney’s fees or the cost of a credit report ordered by the lender.
- Escrow services: For taxes, insurance, etc.
Closing costs and fees run anywhere from 2% to 6% of your outstanding principal balance, similar to the percentage of the loan amount you’d pay for a purchase mortgage. For example: If you still owe $150,000 on your home, expect to pay $3,000 to $9,000 in refinancing fees.
It’s always a good idea to apply to more than one lender to make sure you get the best deal.
🤓 Nerdy Tip
Is your mortgage less than 3 years old? Read the fine print before you refinance. Some loans have a fee, called a prepayment penalty, if you pay off your balance early. Then: Figure out your monthly savings
Now that you know how much you’ll spend, it’s time to figure out how much you’ll save.
Your Loan Estimate will break down your new monthly payment, which includes principal and interest, mortgage insurance (if applicable) and escrow payments.
How to calculate it:
Old monthly mortgage payment - New monthly mortgage payment = Monthly savings.
Example calculation:
If your old monthly payment was $2,300 and your new monthly payment is $2,100, it would look like this:
$2,300 - $2,100 = $200.
In this example, you’d save $200 per month. (Nice!)
Finally: Calculate the break-even point
Now, it’s time to calculate how many months it will take to recoup your refinance costs.
How to calculate it:
Total loan costs / Monthly savings = Number of months it will take break even.
Example calculation:
Let's say the refinancing fees will total $5,000, and you will save $200 a month. Following the above formula:
5,000 / 200 = 25.
That means it will take 25 months, or a little more than two years, to recoup the cost of refinancing. Everything beyond that 25-month break-even point will be total cost savings.
Is it always worth it to refinance?
There is some small print attached to this savings celebration: Even if rates have decreased since you took out your mortgage, your savings may vary in some circumstances, for example, if:
- You extend the term of the loan: If the number of months that you’ll pay on your new refinance exceeds the number of payments that remained on your original loan — say, refinancing to a new 30-year loan — you could end up paying a boatload of extra interest.
- You plan on moving soon: You might not reap the savings if you move before your break-even point.
- Your credit score has fallen: Mortgage rates are tied to your credit score, with the best rates going to borrowers with the highest scores. (Read our tips for refinancing a mortgage with bad credit.)
If you’re facing any of these circumstances, you'll have to do the math and decide whether the decision is worth it.
Another way to save: Refinance to a shorter term
If you want to pay off your home loan in fewer years by refinancing to a shorter term, you stand to save more in the long run than if you maintained your original mortgage term. When you refinance to a shorter term, it’s not about having a lower monthly payment, but about saving big money in total interest.
For example: If you've been paying a 30-year mortgage for five years, you have 25 years remaining on the loan. Let’s assume your financial situation has improved since then; maybe you got a big raise or paid off other debt, like a car or student loan, and you can afford to pay more on your mortgage.
If you refinance to a lower rate, you might be able to afford refinancing to a 15-year loan, or maybe a 20-year mortgage. The monthly payment might rise, but you could save thousands of dollars in interest in the long run.
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