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If you’ve been following the real estate market at all recently, you’ve probably heard that interest rates are at historic lows and, as a result, everyone and their mother is trying to refinance their mortgages right now.
The truth is, refinancing can be a great way to save money. It can help you lower your monthly payment and change the terms of your loan into ones that are more favorable for you. That said, refinancing right now is not for everyone.
Put simply, the math doesn’t always work. In fact, I recently tried to refinance the loan on my new house and, after looking at the numbers, I decided to keep my current mortgage.
With that in mind, let me walk you through the reasons why I knew refinancing wasn’t a good choice for me and how to do your own refinancing math to figure out if it makes sense for you.
The reason my refinance didn’t work
The main reason my refinance attempt didn’t work out was because of the closing costs. Since refinancing is basically just taking out a new loan to pay off your old one, you still pay closing costs when you refinance.
These days, your closing costs are either rolled into the loan when you refinance and you pay them off over time, or you can pay them up front. Unfortunately, neither scenario made financial sense for me.
When the closing costs were rolled into the loan, my monthly payment stayed about the same
Obviously, if you roll your closing costs into your loan, the major benefit is that you don’t have to come to the closing table with a lot of money like you did when you first bought your home. However, the downside is that your monthly payment is going to be slightly higher than it would be if you had paid the closing costs up front.
In my case, rolling the closing costs into my loan didn’t make any sense at all. In fact, even though the interest rate on the new loan would have been almost half a point lower than when I originally took out my loan, the monthly payment on my refinance would have been $0.43 higher than what I currently pay on my mortgage each month.
I know $0.43 may not seem like much of a difference, but it rarely makes sense to refinance if your new payment is going to be higher than your old one. If that occurs, you will want to be assured that you could pay off your loan in a much shorter timeframe, which was not the case for me.
When I paid the costs upfront, my break-even point was too far away
On the other hand, if you decide to pay your closing costs up front, the downside is that you do have to come to closing with quite a lot of money, usually a few thousand dollars. However, the benefit in this case is that your monthly payment is often even lower.
That said, you shouldn’t just write off the money you paid in closing costs. Instead, you should do what’s known as a break-even point calculation to determine how long it will take you to make up the total upfront cost of your closing costs with the savings from your new loan.
With my loan, I was originally pleased to find out that I could save around $50 a month if I paid my closing costs upfront. However, when I did my break-even point calculation, I found out that it would take me more than eight years to break even on the cost of my refinance. For me, that was way too long to justify taking out a new loan.
The formula for finding your own break-even point
Usually, if you plan to roll your closing costs into your new loan, finding the difference in payment is fairly simple. All you need to do is look at the total monthly payment given to you by your lender on your loan estimate.
Finding the break-even point, on the other hand, can be a different story. That requires a little bit of math. To that end, below is an explanation of how to find your own break-even point.
The formula for finding a break-even point is:
Break-even point (in months) = Total closing costs / Monthly savings amount
For example, if it costs $4,000 for you to close on your new loan and you would save $100 a month on your mortgage payment, the equation would look like:
Break-even point (in months) = $4,000 / $100
Break-even point = 40 months or 3.33 years
While there’s no exact science to how long it should take to break even for a refinance to make financial sense, one study found that it takes the average homeowner four years to break even on their closing costs.
As my refinancing attempt shows, the math may not always work out in your favor. While calculating your break-even point can give you a better idea of whether or not it makes sense…
Read More: The formula I used to decide on refinancing my mortgage