Abstract
Under current low interest rates, the decision whether or not to refinance a mortgage is a timely and practically useful topic. However, the home mortgage refinancing decision is also affected by other variables such as personal tax rate. In addition, financial institutions provide different types of mortgage loans in terms of maturity (loan period), interest rate, processing cost, points (bank fee), and so forth. Several websites are available which can be used to aid making the refinancing decision. However, these websites programs are not explicitly geared towards selecting a low cost mortgage loan. Furthermore, these websites are limited in their usefulness due to inadequate assumptions or the difficulty of acquiring information required for the program. For example, a certain website requires information such as the expected future interest rate, the expected inflation rate, the standard deviation of mortgage interest rates, and so forth. To be practically useful, the assumptions should be simple and reasonably realistic. The objective of this paper is to prepare, under realistically reasonable assumptions, an Excel program which can select a low cost mortgage loan after consideration of the tax deductibility of mortgage interest rate. This paper can be used as a case problem for both undergraduate and MBA students. From the case, students learn how Excel (or any spread sheet program) can be programed and used to analyze finance problems.
Highlights
Research papers on mortgage refinancing decision proposed different methods such as the internal rate of return method (Valachi, [6]) and NPV method (Followill and Johnson, [3])
If the loan period is different, it is not an easy issue to examine the impact of the tax deductibility of mortgage interest payment on refinancing decision because the tax shields are occurring every year over the remaining mortgage period and the tax shields are different between original loan and the new loan due to the different interest rate
Assuming that John has just paid the 60th monthly mortgage payment and his income tax rate is 30%, this paper provides an Excel program which can be used to derive the following information: An Excel program was prepared to compute the following: 1) The annual interest rate of the original mortgage loan 2) The current loan balance of the original loan (CLB). 3) The total amount of new loan (NL) which includes the loan processing cost, bank fee, etc
Summary
Research papers on mortgage refinancing decision proposed different methods such as the internal rate of return method (Valachi, [6]) and NPV method (Followill and Johnson, [3]). Mortgage loans can be refinanced with a mortgage whose maturity is longer, equal to, or less than the remaining period of the existing mortgage. If the loan period is different, it is not an easy issue to examine the impact of the tax deductibility of mortgage interest payment on refinancing decision because the tax shields are occurring every year over the remaining mortgage period and the tax shields are different between original loan and the new loan due to the different interest rate. The loan will not be paid off until the maturity of the new loan (no prepayment)
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