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Ask Dave

The Break-Even Analysis

Dave gives Dora a break-even analysis, where she can learn if it's worth it to refinance her house.

QUESTION: Dora and her husband make $200,000 and have no kids. They only owe $99,000 on their home, and it’s worth $130,000. They are in their third year of a 15-year mortgage at 7.25% interest. Should they refinance at a 6.5% rate if they spend $4,000 in closing costs? Dave tells them how to do a break-even analysis.

ANSWER: Doing that saves you three-quarters of a point; on a $100,000 mortgage, that equals out to about $750 a year. If it costs you $4,000 in closing costs, then it would take you 5 years to get your money back. That’s not a good deal because that $4,000 probably includes points.

You need to get a par quote for a refinance, which is zero points and zero origination. Then analyze it again … based on that scenario, you would save half a point instead of three quarters, but if you only had $2,000 in closing costs with that, then it would take me 4 years to recoup the cost. If you’re going to be in the house longer than 4 years, then it’s worth it. But you’re not going to make any money on the refinance until you paid your closing costs back with the interest money you saved.

That’s called a break-even analysis. Just divide your costs by your savings, and it tells you how many years it takes you to get your money back. If you’re going to keep the home longer than that, then it makes sense to refinance. You are in a borderline situation as to whether it will make sense or not. If rates drop again, I would put you in the category to do that. But right now, you’re borderline.

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