How to Use Your Refinance Break Even Point to Maximize Savings

Posted by Chris on September 24, 2014

When someone decides to refinance their home loan it usually boils down to an attempt to save some money. And that's awesome! It can be very gratifying to save money on one of the biggest purchases you'll make in your life. To ensure you get the biggest financial benefit from your refinance you should know to stay in your home after you refinance.

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Mortgage and tax experts agree that the benefits of refinancing are realized over time. The longer you stay in the home, the more money refinancing saves you. The reason for this are costs. Even though refinancing your mortgage saves you money in several significant ways, there are still closing costs. To determine if refinancing is in your best interest then you'll need to consider these costs and find your break even point.

Here is how a refinancing can save money:

  • by lowering the interest rate
  • by getting a fixed rate rather than an adjustable or variable rate
  • by shortening the term of the loan which helps the homeowner to pay it off sooner (e.g. refinance a 30-year loan with a 20-year mortgage)
  • by having a lower monthly payment and using the extra cash for home improvements, other expenses or investments

To understand if refinancing is a good idea you'll need to do a little math. Remember that time builds equity or value in your home. The longer you stay in the home, the more equity you have. Additionally, the longer you stay in your home after you refinance the longer you have to recover the closing costs. How long you plan to stay in your home after refinancing is one of the the biggest factors to consider before refinancing.

When you refinance you'll incur many of the same closing costs associated with obtaining a purchase loan. The main costs associated with refinancing your home loan are appraisal fees, title insurance, a credit check, and closing costs. You should expect to see these costs outlined in your good faith estimate for your new loan. Typically, the fees on a refinance are equal to 3 to 6 percent of the value of the loan.

Figuring out how long you should stay in your home after refinancing

You can use our online refinance calculator to find out if refinancing is a good choice for you. The calculator will tell you what your refinance break even point is so you can make a good decision.

If you don't want to use a refinance calculator you can use this common sense, 2-step formula to help you estimate your monthly savings and figure out how much time it will take to recover your closing costs.

Once you have a loan quote with a new payment you'll be able to use this 2-step formula to easily figure out your break even point.

1. Original mortgage payment - New payment = Monthly savings.
2. Closing costs divided by Monthly savings= Number of months needed to recoup the closing costs.

For instance, if your closing costs are $3,000, and the monthly savings on the mortgage payment are $150, it will take 20 months for you to break even. This means you'll begin realizing savings in month 21. Everything from that point forward is money in your pocket.

Don't forget taxes!

You should also consider income taxes. Refinancing can affect how much income tax you pay. Getting a lower rate is great but this could mean having less interest to deduct from your taxes. Usually the amount of money you'll save by refinancing to a lower rate or payment will far exceed any increase in taxes.

Also keep in mind that mortgage points paid during your refinance could be fully deducted on your tax return. If you're able to deduct your loan points it's most common to deduct them over the life of the loan. So if you refinanced to a 15 year loan you'll be able to deduct 1/15 of your points on your taxes in the first year and so on. So even though you might have less interest to deduct other deductions might be available to you. To thoroughly understand all the tax implications of refinancing your home loan, consult a tax professional.

So how long should you stay in your refinanced home to realize the biggest financial benefit? The answer depends on several factors, but in general, the longer you live there, the greater your financial benefit is. Sit down, and do the math before refinancing. Then, you will feel more confident that the new loan will be the right choice for your goals.

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Topics: Refinancing 101