John took a mortgage loan 5 years ago for $120,000 at 7% interest for 15 years,
ID: 2717166 • Letter: J
Question
John took a mortgage loan 5 years ago for $120,000 at 7% interest for 15 years, to be paid in monthly payments. Now, a lender is offering him a new mortgage loan at 5% for 10 years. The new loan amount is $92,895, the outstanding loan balance of the existing loan. Suppose that a prepayment penalty of 3% must be paid if John refinances the existing loan. Moreover, the lender who is making the new loan requires an origination fee of $3,000. John plans to hold the property for 10 years. Note: John has to pay the refinancing fees (i.e., the origination fee and the prepayment penalty) out of his pocket.
(a) What is the total financing cost (not include the loan amount itself) if John decides to refinance the old loan?
(b) What is the monthly savings that John could realize by refinancing?
(c) Given the information provided here, should John refinance? Please support your answer by calculating the effective interest rate of the new loan.
(d) Now suppose that John’s current income is low. The new lender allows him to pay a monthly payment of $300 for the new loan (i.e., the actual monthly payment to the lender is only $300, while the loan interest rate is 5%). In this situation, negative amortization occurs. What will be the accrued interest or the amount of increased loan balance for the loan three years later from now?
(e) Assume that John has to borrow two loans in order to refinance. That is, he has to borrow a new mortgage ($70,000) at 5% for 10 years (i.e., the loan maturity and the amortization period are the same, 10 years) and another mortgage ($22,895) at 9% for 5 years (the loan maturity and the amortization period are the same, 5 years). In this case, with the same origination fee of $3,000 (i.e., a total of $3,000 for the two loans) and the prepayment penalty of 3%, should John go ahead with the refinancing plan? Why?
(I primarily need assistance with Sections D and E as I believe I have A-C correct)
Explanation / Answer
D. The loan that has to be paid is 92,895 at 5% interest per annum. So the annula interest payable will be 92895*0.05 = 4644.75 for a year. For a month He as to be 4644.75/12 = 387.0625.
However since he pys only 300 there is a balance of 87.0625 each month. For three years, this will be 87.0625*12*3 = $3134.25
Hence Increased Loan balance by $3,134.25 in 3 years
E. In this case the total interest pyable would be 70000*0.05*10 + 22895*0.05*5 = 45,302.75
The total payable outsanding is 92895+45302.75+ 3000+ 3% prepayment
In the orginal case the interest payable would be 92895*0.07*10 = 65,026.5.
The benefit he gets is only 65026.5 -45302.75 = 19,732.75 which is more than refinancing Cost. hence he should go ahead with this plan
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