The Refinance Breakeven: Points vs. Rate

Rates have dropped. Your inbox is full of offers: "Refinance now and save $300/month!" It sounds tempting. But in the mortgage industry, "Saving Monthly" != "Saving Money".

The Problem: The Friction Cost

Refinancing isn't free. Between origination fees, appraisal fees, title insurance, and "Discount Points" (prepaid interest to buy down the rate), closing costs can easily run $5,000 to $15,000. The lender rolls these costs into your new loan. So, your balance goes UP, even if your rate goes DOWN.

The Agitation: The Moving Target

Here is the trap: How long will you stay in the house? If you spend $10,000 in fees to save $200 a month, it will take you 50 months (over 4 years) just to break even. If you sell the house or move in 3 years, you actually lost money by refinancing, even with the lower rate. You paid $10,000 upfront to save $7,200. You are in the red.

The Solution: Calculate the "Breakeven Month"

Never refinance based on the "Monthly Payment." Refinance based on the Breakeven Point. If your Breakeven Point is 30 months away, and you plan to live there for 10 years, do it. If you might move for a new job in 2 years, throw the offer in the trash.

The Amorti Simulation

Use AmortiApp to verify the lender's math. To do this, follow these steps: Scenario A (Current Loan): Run a simulation for the remaining* years of your current loan. Note the "Total Interest Remaining".

Scenario B (Refinance):

* New Principal = Current Balance + Closing Costs. * New Rate = The lower rate. * New Term = 30 Years (Careful! Resetting the clock costs money).

Compare the Total Interest of A vs. B. Often, you will find that extending a 22-year loan back to 30 years costs MORE in total interest, even with a lower rate.

Understanding the Breakeven Analysis

The Breakeven Analysis is a crucial step in determining whether refinancing is right for you. It takes into account the costs associated with refinancing, such as closing costs, and the potential savings from a lower interest rate. By calculating the Breakeven Point, you can determine how long it will take for the savings from the lower interest rate to offset the costs of refinancing.

Key Takeaways

Refinancing is not always the best option, even with a lower interest rate.

Closing costs can be significant and should be factored into your decision.

The Breakeven Analysis is a crucial step in determining whether refinancing is right for you.

You should consider how long you plan to stay in your home when deciding whether to refinance.

Example of a Breakeven Analysis

Let's say you have a current loan balance of $200,000 with an interest rate of 4% and 20 years remaining on the loan. You are offered a refinancing option with an interest rate of 3.5% and closing costs of $10,000. To calculate the Breakeven Point, you would need to determine the monthly savings from the lower interest rate and divide the closing costs by the monthly savings.

For example:

Current monthly payment: $1,073

New monthly payment: $934

Monthly savings: $139

Closing costs: $10,000

Breakeven Point: $10,000 / $139 = 72 months (or approximately 6 years)

In this example, it would take approximately 6 years for the savings from the lower interest rate to offset the costs of refinancing. If you plan to stay in your home for more than 6 years, refinancing may be a good option for you. However, if you plan to move in less than 6 years, you may want to consider other options.

Points vs. Rate

When considering refinancing, you may also be offered the option to pay points to lower your interest rate. Points are a type of prepaid interest that can help reduce your monthly payment. However, points can also increase the upfront costs of refinancing.

For example:

Interest rate: 3.5%

Points: 1%

Closing costs: $10,000 + $2,000 (1% of the loan amount)

New monthly payment: $914

In this example, paying 1 point to lower the interest rate would increase the upfront costs of refinancing by $2,000. However, it would also reduce the monthly payment by $20. You would need to consider whether the savings from the lower interest rate are worth the increased upfront costs.

Don't Get Sold, Get Calculated

Refinancing can be a complex and overwhelming process. However, by doing your research and carefully considering your options, you can make an informed decision that is right for you. Don't just rely on the lender's math - use tools like AmortiApp to verify the calculations and determine whether refinancing is a good option for you. Remember, "Saving Monthly" != "Saving Money". Always calculate the Breakeven Point and consider how long you plan to stay in your home before making a decision.