(45 points) You obtained a fully amortizing mortgage 5 years ago for $135,000 at 4.25% for 30

years. Mortgage rates have dropped so that a fully amortizing 25-year loan can be obtained

for 3.50%. There is no prepayment penalty on the mortgage balance of the original loan, but

2 points will be charged on the new loan (i.e. 2% of the OLB) and other closing costs will be

$2,000. All payments are monthly.

a.

(8 points) Calculate the IRR of refinancing if you plan to be in the home for the

remaining loan term (i.e. 25 years). What should you do and why?

b.

(10 points) Calculate the NPV of refinancing (using the uncompounded

effective

borrowing cost

on the new loan as a discount rate) if you plan to be in the home

for the remaining loan term (i.e. 25 years). What should you do and why?

c.

(15 points) Building on 1b., what level of cost (i.e. lump sum plus the points of 2%

of OLB) makes the NPV of refinancing equal to zero? That is, you are indifferent

between refinancing or not. What is the relationship between the effective

borrowing cost on the new loan and the rate on your existing loan when you are

indifferent?

d.

(12 points) Calculate the IRR of refinancing if you plan to be in the home for only

five more years? What should you do and why? Just assume the original 2% fee

plus $2,000 in other closing costs.