You currently have a $325,000 30 year fully amortizing fixed rate mortgage with a 5.5% rate (Loan A). You had to pay $2,000 in origination fees to get Loan A. After making payments on this loan for 4 years, you consider refinancing your mortgage. The new loan (Loan B) would be for 26 years, also be a fixed rate fully amortizing mortgage and have a 4.25% rate. In order to get Loan B you will need to pay $4,000 in origination fees and your old loan, Loan A, has a 2.5% prepayment penalty if you prepay in the first 5 years. You would pay any fees associated with the new loan, Loan B, in cash.
1. If you plan to hold the new loan for 5 years and you have an alternative investment of similar risk and time horizon that pays 5%, should you refinance? Yes or no? Why?
2. If you hold the new loan until maturity, what IRR will you earn on this refinance? Round to two decimal places.
3. If you hold the new loan until maturity, what is the effective interest rate on the new loan? Based on this information, should you refinance? Yes or no? Why?