The break even point of a mortgage is the period in time in the future when the borrower starts to save money or experience an increase in savings.
Break even points are most often referenced in two situations:
- When a borrower is considering the points of a new loan
- When a homeowner is considering refinancing the existing loan
When a home buyer goes to a lender to apply for a mortgage, he might be quoted a variety of interest rates to select from.
This might include the choice of either one at 5% with 1 point and one with 5.25% with 0 points.
In this case, the borrower needs to calculate the break even period where the first loan would start to mean more savings than the second loan.
Because the first loan come with 1 point among the settlement costs, the extra expense incurred will be offset by the reduction in interest rates of 0.25%.
The break even point is the moment when the savings from interest rates equate to the points paid upfront.
Moving on to refinancing.
When a home owner is refinancing with a new lender, he would incur closing costs for the new loan that is replacing the current one.
Assuming the new loan has a lower interest rate than the current one, at some point in the future, the savings made on the lower interest would equal that of the settlement costs which he paid upfront.
This is the mortgage break even point.
Only by holding onto the new loan beyond this break even point will the borrower be able to reap the benefits of refinancing in the form of savings.
In this case, if the borrower might be able to significantly reduce the closing costs should he refinance with the current lender.
If that happens, then the break even point would be sooner than moving to another lender that charges a higher closing cost.