True break-even point of a refinance

I mentioned in an earlier post that a decision to refinance often involves a calculation of the "break-even" point. A much-simplified version of this calculation is to take the cost of the loan and divide it by the amount each monthly payment is lowered. However, this fails to take into account the loan term: refinancing a 15-year loan into a 30-year one will drop your payments considerably, but at substantial cost in the long run. Even just refinancing from a partially-paid-off 30-year loan to a new full-term loan will drop the payment while extending the payoff.

A better indicator of true value here is the interest paid each month. This is entirely dependent on the interest rate and the outstanding balance on the loan.

Using this metric makes a 15-year loan look much better, which (let's face it) it is. The main draw is that the interest rates on 15-year loans are tons lower (over half a percentage point) than 30-year rates. On a large (200K) mortgage balance, this can mean a difference of eighty dollars or more in interest each month, no small change. The monthly payment is still higher (ours was 40% bigger when we switched), but it's because you're paying off your loan instead of paying basically only interest.

If you can afford a 15-year repayment schedule, it sure is worth a look in our current interest rate environment.