Question

Question 2: Breaking a Mortgage

Consider entering into the following mortgage:

• Size of initial loan = $450,000 (ignore any possible insurance)

• 3-year term.

• Closed, fixed rate of interest equal to 4.5% APR.

• 20-year amortization period.

• Monthly payments.

Part A: Please compute the monthly payments and determine how much principal is left after one year of payments (assuming no change in interest rates).

Part B: Assume that, after one year of payments, interest rates drop to 3.65% APR. Would you break the mortgage and refinance at the new rate? Please show all relevant calculations and ex-plain your choice. Do not forget to state any assumptions you make in arriving at your answer.

Answer 1

Formula Used:-

Part-A Monthly Payment=PMT(C47/12,C46*12,-C45)

Value of Loan after 1 year=FV(C47/12,12,C48,-C45)

New Monthly Payment=PMT(C53/12,C52*12,-C51*(1+C50),)

So according to above calcultion the new loan will reduce the monthly installment so we should re-finance with the new loan but here one thing that we have to take in mind that I have assumed the pre-payment penalty at 1% if it is higher it can change our decision.