How Long Does it Take Break Even With a Home ReFi?

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Refinancing your mortgage loan to one with a lower interest rate makes good financial sense — usually. It all depends on how much lower your interest rate will be, how much you owe on your loan, and how long you plan to stay in your home.

Refinancing a mortgage isn't free. Costs vary by lender, but you can expect to pay from 1.5 percent to 2 percent of your outstanding loan balance to close a refinance. If you owe $200,000 on your mortgage loan, that comes out to $3,000 to $4,000 — no small amount. But if your monthly mortgage loan drops by enough, you'll recoup those costs quickly. Then, the savings you enjoy each month will start adding up.

Determining how long it will take you to break even on your refinance requires a bit of math. Let's crunch the numbers.

Finding the break-even point

Say you have been paying off a $250,000 30-year, fixed-rate mortgage with an interest rate of 4.50 percent. Your monthly mortgage payment — not including the extra costs of property taxes and homeowners insurance — will be about $1,266.

Now, say when you're ready to refinance, your mortgage balance is down to $200,000. If you refinance that balance to a new 30-year, fixed-rate mortgage with an interest rate of 3.85 percent, your estimated monthly payment, again not including taxes and insurance, will fall to about $937 a month. That's a savings of about $329 a month, or $3,948 a year.

If you spent $3,000 in closing costs on your refinance, you'd hit the break-even point on your loan in less than a year.

But refinancing doesn't always come with such a quick payback period.

For example, if you have been paying off a 30-year, fixed-rate loan of $200,000 at an interest rate of 4.15 percent, your monthly payment, not including taxes and insurance, would be about $972. Say you now owe $190,000 on this loan and you refinance it to a 30-year, fixed-rate loan with an interest rate of 3.85 percent. This will drop your monthly payment to about $890, a difference of $82 a month or about $948 a year.

If it costs you $3,000 to refinance that mortgage, it will take you a little more than three years to hit the break-even point. If you plan on living in your home and paying off your new mortgage for more than these three years, this refinance might still make financial sense. The payback period, though, won't be quite as quick.

Speeding up break-even

You can reduce the amount of time it takes you to reach the break-even point in several ways.

First, you can shop around for a mortgage lender that charges lower fees. You are free to close your refinance with any lender that is licensed to do business in your state. You don't have to work with the lender to which you are already sending your monthly mortgage payments. Obviously, the lower your upfront costs to refinance, the quicker you'll hit your break-even point.

Nabbing the lowest possible interest rate also will help speed up the break-even point. The lower your rate, the lower your monthly payment will be. Getting a lower rate, though, requires a strong credit score.

Before applying for a refinance, order free copies of your credit reports from AnnualCreditReport.com. These reports won't give you your credit score, but they will show you whether you have any late or missed payments on your record. Such financial dings will lower your credit score. If you have blemishes on your credit reports, qualifying for an interest rate low enough to make a refinance worthwhile might not be possible.

You can also order your FICO score from the three national credit bureaus: TransUnion, Equifax, or Experian. This will usually cost you about $15, but will let you know for sure how high or low your credit score is. If you want to get your score for free, you can call a lender and explain that you want to refinance. This lender will often check your current score, and can let you know immediately whether it is high enough to justify a refinance.

Finally, the more you've paid off on your existing mortgage before you refinance, the quicker you'll reach your break-even point. Most lenders won't approve you for a refinance unless you've already built up 20 percent equity in your home. So don't run to refinance just a year after taking out your existing mortgage. Unless your home has shot up in value dramatically, you probably won't have enough equity to qualify for a refinance, or to make it financially worthwhile.

Other factors to consider

Of course, lowering your monthly payment isn't the only reason to refinance. You also want to reduce the amount of interest you pay on your loan.

That's why you might consider refinancing from a longer-term loan to one with a shorter term. Doing so will usually increase your monthly payment because you are cutting the number of years it takes you to repay your mortgage. But refinancing from a 30-year, fixed-rate loan to a 15-year, fixed-rate loan could save you plenty in interest.

If you take out a 30-year, fixed-rate mortgage of $200,000 at an interest rate of 4.2 percent, you'll pay more than $150,000 in interest if you take the full 30 years to pay off your loan. If you instead take out a 15-year, fixed-rate loan for $200,000 at an interest rate of 3.5 percent, you'll pay less than $60,000 in interest if you take the full term to pay off this loan.

The best move to make when considering a refinance is to go over the numbers with a mortgage lender. A lender won't charge you for a preliminary look at your mortgage and credit. But a lender will be able to tell you how long it will take to recover the costs of refinancing and whether you'll qualify for a low enough interest rate to make refinancing a viable choice.

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