MORTGAGE REFINANCE ISSUES In a market where interest rates are declining many homeowners face the decision to refinance an existing mortgage, particularly those homeowners who obtained mortgages when interest rates were historically at high levels. This effect was particularly evident during the late 1980's with homeowners who had obtained mortgages at interest rates as high as 16% in 1982 could refinance their mortgage as low as 8% in 1986, The decision to refinance is not that trivial since banks have closing costs which the homeowner must absorb upfront in order to obtain a new mortgage. The decision to refinance depends upon several factors including the level of closing costs, the amount of time the homeowner plans to hold the mortgage, and the difference in interest rates Consider the following situation: Mr. Johnson obtained a 30 year fixed rate mortgage on January 1st, 1995 with the following characteristics: Loan Amount = $300,000 APR 100 i(12) = 10.2% Monthly Payment = $2,677.16 The first payment was made on February 1,1995. In 2001, Mr. Johnson was faced with a refinance decision. He could obtain a 30 year fixed rate mortgage at an APR of 8.70%. His house was appraised at $600,000 in 1998 and he could have any loan amount up to 80% of the value of his property. The closing cost schedule is as follows: Origination Fee = 3% of LOAN AMOUNT Attorney's Fee = $500 Miscellaneous Costs = $1,000