In this article I’ll tell you about Mortgage Refinancing: The Break-Even Period. In general terms, when you calculate the break-even of a business investment, it is the time at which you have covered your costs with revenue. So if you add a piece of machinery to your factory, if it cost $20,000 and you have a repair savings each year of $5,000 due to consistent uptime, the break-even period would be four years. In four years, you would have paid for the machinery because you saved 5k each year.
That was rather a simple mathematical calculation, but how do you determine the break-even period for mortgage refinancing? Unless you are renting out your home, you do not receive any revenue per se on the mortgage, but you do make payments.
Unquestionably, many factors enter into the break-even derivation. In fact, there are many different break-even periods as far as mortgages are concerned, and depending on what a person wishes to conclude. For example, one might want to know the break-even period on the after-tax savings, others might need to know PMI and interest savings, and yet again some are interested in monthly payment savings. Each person’s circumstances will be different. Buying points to reduce interest might be something else that factors into the equation.
One thing that is constant throughout the calculations when dealing with mortgage refinancing and the break-even period are the closing costs. All other expenses are matched against the closing costs. Like our example of machinery, the closing costs of the mortgage are the cost of the machinery, and the savings from interest and private mortgage insurance is equated to the repair savings in a factory.
To determine the break-even period, you are trying to find out how many months it will take for interest and PMI to exceed the closing costs putting you effectively in a positive position. From a purely accounting standpoint, the interest would be after-tax interest.
Admittedly, most people would not even think about the break-even period when mortgage refinancing. The truth is the majority cannot even get their head around the calculations and probably see little benefit in completing the task. For someone with financial hardship wishing to refinance to feel a little relief, break-even points are beyond the scope of the exercise. In fact, most would not even know how to start without an online break-even calculator wherein you type in your numbers and the site comes back with an answer.
Having said that, however, there are many instances where financially it is prudent to know the numbers, as you can make more informed decisions and impact your future in a more positive light.