You are the owner of a property valued at $1 million. You purchased the property 5 years ago for $750,000. The original loan you obtained to finance the property had a 70% loan to value ratio, an interest rate of 10%, and the monthly mortgage payment is approximately $4,771. The balance on the first loan after 5 years is $482,500. You are thinking of refinancing to get out some of your equity in the property. Currently interest rates are at 9% for a 25-year loan with a 70% loan to value ratio. The monthly amortization factor for this loan would be 0.008392. Since you anticipate selling the property in 5 years, in order to calculate the cost of obtaining capital in this way, you will need to know the loan balance five years down the road. The balance on the existing loan will be approximately $443,947 in 5 more years. For the new loan, the loan balance factor after 5 years would be 0.932724.
Without solving this internal rate problem, do you think the marginal cost you would find would be greater or less than 9 percent? Why?
Answer is: Less Than 9% because you have reduced the cost of 482,500 by 1%
Could someone explain/elaborate on this answer?