A principle that is usually followed in a refinance mortgage market is that the mortgage rate should be atleast 2% lower than the existing loan rate. But the lower interest rate cannot be termed as the sole indicator of a good mortgage refinance deal. The new mortgage has various costs associated with it like closing costs, settlement costs etc which add to the amount a person needs to pay. The person taking up mortgage refinance recovers these costs over the mortgage tenure in the form of cash savings due to lower interest rate mortgage. It is said that sooner the person recovers the loan costs, better is his mortgage deal. This critical factor used to evaluate mortgage refinance is known as the break even period of mortgage finance.

Break even period is the time when the person breaks even the costs incurred while taking refinance. Breaking even the costs means the person has recovered the amount of money he paid as fees and other costs while taking the mortgage. Lower the rate of mortgage, sooner will the person reach the break even period. Thus if a person, in most ideal situation, gets a refinance at zero cost, break even period for his loan will be reached immediately.

One way in which break even period can be calculated is to divide the amount of mortgage refinance by the monthly saving in loan payment. But it does not consider the lower interest rate and term length. Another way of calculating the breakeven period is by taking the help of a broker or using mortgage calculators available online.

There is some basic data required to calculate the break even period using mortgage calculators which include –

• Income tax rate applicable to the person

• Term remaining on the existing loan

• Term of the new loan (refinance term loan)

• Refinance costs were paid in cash or refinanced

There are some important factors that are missed while calculating breakeven and hence sometimes, the break even period calculated by the person may not be right. It does not include –

• Tax Deductions available

• Time Value of Money

• Balance of Loan (Difference between amount of original mortgage and refinanced mortgage)

If a person plans to stay in the same house for a period more than the break even period, it is considered as a good mortgage. Also, larger the gap between the new and original rate of interest, shorter is the break even period.

Many times people avoid calculating the break even period, but they realize it later that a small short cut has turned in to a grave mistake as break even period is an indicator of when the person will actually start saving due to lower monthly installments. People who ignore this fact are in an illusion that they are saving money due to lower interest rates while the ironical fact is that they are losing money instead of saving and hence it is rightly said ‘Small things make a big difference’.