Question

4)Given the recent drop in mortgage interest rates, you have decided to refinance your home. Exactly five years ago, you obtained a $550,000, 30-year mortgage loan (L1) with a fixed rate of 5.5%. Today, you can get a 30-year loan for the currently outstanding loan balance at 3.75% interest. This loan (L2), however, requires you to pay $3,000 in front-end fees and 2 points at the time of the refinancing (1 point equals 1% of the amount borrowed). Ignore tax considerations

(i). What is the outstanding balance on the L1 loan today, if you just made the 60th payment? (2 pt.)

(ii). How much will your monthly payments be for L2 after you refinance? (3 pt.)

(iii) Should you refinance? Answer this question by computing your effective borrowing cost on L2 and comparing it with L1. Show your computations. (5 pt.)

Answer 1

	(i)	Outstanding Loan Balance (Li) at end of 60 months:
	Rate	Monthly interest rate on existing loan=(5.5/12)%	0.4583%
	Nper	Number of months of mortgage =30*12=	360
	Pv	Amount of loan	$550,000
	PMT	Monthly payment on existing loan	$3,122.84
		(Using PMT function of excel)
		Outstanding Loan Balance at end of 60 months=Present Value of future payments for balance(360-60)=300 months
	Rate	Monthly interest rate on existing loanL1=(5.5/12)%	0.4583%
	Nper	Number of months of future payments	300
	Pmt	Monthly payment on existing loan	$3,122.84
	PV	Outstanding Loan Balance at end of 60 months=	$508,533.32
		(Using PV function of excel)
	(ii)	Monthly Payment for L2
	Rate	Monthly interest rate on L2 loan=(3.75/12)%	0.3125%
	Nper	Number of months of mortgage =30*12=	360
	Pv	Amount of loan	$508,533.32
	PMT	Monthly payment on L2 loan	$2,355.10
		(Using PMT function of excel)
	iii)	Effective borrowing cost of L2
		Amount of loan	$508,533.32
		Less: Front end fees	$3,000
		Less: Payments for points=2%*508533.32	$10,170.67
	Pv	Effective amount borrowed	$495,362.65
	Nper	Number of months of mortgage =30*12=	360
	Pmt	Monthly payment on L2 loan	$2,355.10
	RATE	Effective Monthly borrowing Cost of L2	0.3305%
		(Using RATE function of excel)
		Effective borrowing cost is lower than L1 Loan
		He should refinance