The break-even point is the number of months a borrower must keep the new loan before the cumulative monthly savings exceed the upfront closing costs. Every refinance conversation should start here. A borrower who moves in 18 months should not pay $6,000 in closing costs to save $150/month -- the math does not work even if the rate looks attractive.
The Basic Break-Even Formula
Divide total closing costs by monthly payment savings. If closing costs are $5,000 and the new payment is $220/month lower, break-even is 23 months. That is straightforward. The problem is that most MLOs stop there and miss two important refinements: the opportunity cost of deploying closing cost cash elsewhere, and the effect of resetting the amortization clock on a seasoned loan.
Amortization Reset Effect
A borrower 7 years into a 30-year mortgage is paying mostly principal. Refinancing resets the amortization schedule and shifts payments back to mostly interest. Even at a lower rate, total interest paid over the remaining life of the loan may be higher than just continuing the existing mortgage. Present both the monthly savings and the total interest comparison when the loan is more than 5 years old.
Inputs That Change the Calculation
- ✦Points paid up front: each discount point is 1% of the loan amount and must be included in total costs
- ✦Lender credits: if lender credits offset some costs, reduce the total cost input accordingly
- ✦Tax deductibility: points paid on a refinance are deductible over the life of the loan, not in year one
- ✦Escrow impound: prepaid interest and escrow reserves are not true costs -- they are recouped when the old escrow is refunded
Aria can run the full break-even analysis including amortization reset impact for any refinance scenario. Ask at vicariointel.com.
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