You are buying a $350,000 home and have decided on an 80% loan-to-value fixed rate mortgage with 6% interest over 30 years. After 10 years, you are thinking about refinancing for $1,500. You will only be in the home for another 5 years. The new loan would be an ARM. Interest rates on 20-year ARMs are currently 3%. Interest rates are expected to increase to 4% in years 2 and 3 and then to 5% in years 4 and 5.

a. Find the return on your $1,500 refinancing costs. Should you refinance?

b. If interest rates rose faster than expected, how might this change your answer?

c. How would larger than expected increases in interest rates impact the supply and demand for homes?