6. Kevin in California has owned his home for 2 years and expects to live in it for at least 7 years. He originally borrowed $700,000 at 4% interest rate for 15 years to buy the home. He still owes $629,000 on the loan. Interest rate have since fallen to 1.99%, and Kevin is considering refinancing the loan for 13 years to finish the loan as the original planned time. He would have to pay 1 point on the new loan with no prepayment penalty on the current loan. Suppose that the account savings can be invested monthly at 2% interest rate. The possible prepayment penalty and the closing cost can be investment at the beginning of the new loan at 2%, monthly compounding.

a) What is Kevin's current monthly payment?

b) Calculate the monthly payment on the new loan.

c) Advise Kevin on whether he should refinance his mortgage using the Run the Numbers worksheet, "When you Should Refinance Your Mortgage" on page 285

Run the Numbers When You Should Retinance Your Mortgage It is sometimes advantageous to refinance an existing mortgage when interest rates decline. In mortgage refinancing, a new mortgage is obtained to pay off and replace an existing mortgage. Most often it is undertaken to lower the monthly payment on the home by taking out a new loan with a lower interest rate. The example here illustrates how to determine whether refinancing your mortgage is a wise choice. The original mortgage for $160,000 was obtained seven years ago at a 5.5 percent interest rate for 30 years. The monthly payment is $908. After seven years, the principal owed has declined to $142,100. If interest rates for new mortgages have declined to 4.5 percent, the owner could take out a new mortgage at the lower rate for a monthly payment of $827. Borrowing $142,100 for 23 years at 4.5 percent saves approximately $81 per month (\$908 - \$827). However, refinancing may have some upfront costs, including a possible prepayment penalty on the old mortgage and closing costs for the new mortgage. The question then becomes, will these costs exceed the monthly savings gained with a lower payment? The following worksheet provides a means for estimating whether refinancing offers an advantage. It compares the future value of the reduced monthly payments (line 5) with the future value of the money used to pay the up-front costs (estimated here at 2% ) of refinancing (line 8). The homeowner would need to estimate the number of months he or she expects to own the home after refinancing. Given an estimate of four years in this example, the net savings would be $977 (subtracting line 8 from line 5), and refinancing would benefit the owner. In this example, planning to live in the home only three more years would result in it not being financially advantageous to refinance. A similar worksheet can be found at www.bankrate.com/calculators/mortgages/refinancecalculator.aspx. It may also be possible to borrow more than the current balance owed on the existing loan, thereby utilizing some of the equity built up in the home. Borrowers refinancing for more than the amount owed should understand that rebuilding the equity to its previous level may take many years. This also is dangerous because if home prices decline the borrower will owe more on the home than it is worth