When is a good time to refinance?

Abstract

Because of inertia and wish effect, businesses hurt their own future by refusing to take advantage of low interest rates. As a business builds up its equity in the capital structure, the firm could refinance to take advantage of leverage financing. Even when the capital structure is unchanged, the firm may wish to refinance because of a low interest rate. But the business may not refinance because of inertia and wish effect. Decision makers have been reluctant to refinance due to high interest rates. Even when the new rate is lower, they wait for an even better rate. They keep the old high rate and do nothing about it, wishing for the good old days of low interest rates. They just do not venture into new opportunities because of the lack of capital. The nation's economy and productivity are hurt. This paper examines refinancing situations of firms and individuals who use long term loans. The paper then develops four decision models for typical refinancing situations considering such factors as old and new interest rates, capital structure in terms of debt/equity ratio, loan amount, transaction cost, expected rate of return from the best opportunity available, expected inflation rate, and possible changes in interest rates in the future. Based on the decision models, a computerized Refinancing Decision System (RDS) has been developed. The paper discusses the functions and uses of the system showing how each of the decision models has been incorporated in the system. The RDS is a good tool in evaluating refinancing decision situations for individual owners of income properties and similar real properties subject to long term mortgage loans and for the managers of firms that hold plants and have expansion plans. The System can be very useful for the general home owners too, if they wish to reduce the monthly payments of their mortgage loan interest.