How Do I Know Whether Or Not I Will End Up Saving Money When Refinancing My Home Loan?

To save money, you must live in your house longer than the "break-even period" the period over which the interest savings just cover the refinance expenses. The larger the spread between the new interest rate and the rate on your existing loan, the shorter the break-even period. The more it cost to get the new loan, the longer the break-even period. But be careful. The break-even period is not the cost of the new loan divided by the decrease in the monthly mortgage expense. This broadly used rule of thumb is a misapplication of the principle that when explaining something to the buyer one should "keep it simple." Simple is fine, except for when it is wrong. The rule of thumb does not permit for the difference in how rapidly you pay off the new loan as opposed to the old one. Let us say that in you took out an % -year fixed rate loan, which now has a $, balance and years to run. You refinance into a % -year loan at a fee of $,. Monthly expense on the old loan = $ Monthly expense on the new loan = $ Reduction in monthly expense = $ $ divided by $ = months The rule of thumb say that you break-even in months. But, because of the shorter term and lower rate on the new loan, in months you would owe $, less than you would have owed on the old loan. So, the rule of thumb in this case critically overstate the break-even period. Taking account of difference in the loan balance, you would actually be in advance of the game in months, as showed below: Savings in monthly expense: $ for months = $ Plus lower loan balance in month : $ Equals total saving from refinance: $ Less refinance cost: $ Equals net gain: $ Next think about the case where an % loan taken out in was for years, and now has only years to run, while you plan to refinance into a -year loan. With the lasting term shorter on the old loan and longer on the new one, the difference in monthly expense rises to $. Using the rule of thumb the $ cost would be recovered in only months. But this fail to consider the slower loan repayment on the new loan. Taking account of the slower repayment, you do not really come out in advance until months out. The rule of thumb (dividing the upfront cost by the decrease in mortgage expenses) approximates the true break-even period only if the term on your new loan is close to the unexpired term on your old loan. In other circumstances it can lead you critically off course. The rules of thumb also ignore the detail that if you had not refinanced you could have earned interest on the money you pay upfront to refinance; and if you do refinance and the expense is reduced, you can now take home interest on the savings.