When Jacqueline and Keith Sommers were "house hunting" five years
ago, the mortgage rates were pretty high. The fixed rate on a 30-year mort-
gage was 7.25%, while the 15-year fixed rate was at 6.25 %. After walking
through many homes, they finally reached a consensus and decided to buy
a $300,000, two-story house in an up-and-coming suburban neighborhood
in the Midwest. To avoid prepaid mortgage insurance (PMI), the couple
had to borrow from family members and come up with a 20% down pay-
ment and the additional required closing costs. Since Jacqueline and Keith
had already accumulated significant credit card debt and were still paying
off their college loans, they decided to opt for lower monthly payments by
taking on a 30-year mortgage, despite its higher interest rate.
Currently, due to worsening economic conditions, mortgage rates have
come down significantly and a refinancing frenzy is underway. Jacqueline
and Keith have seen 15-year fixed rates (with no closing costs) advertised
at 2.75 %, and 30-year rates at 3.75 %. Jacqueline and Keith realize that
refinancing is quite a hassle due to all the paperwork involved, but with
rates being down to 30-year lows they don't want to let this opportunity
pass them by. About two years ago, rates were down to similar levels, but
they procrastinated and missed the boat. This time, however, the couple
called their mortgage officer at the Uptown Bank and locked in the 2.75%,
15-year rate. Nothing was going to stop them from reducing the costs of
paying off their dream house this time!

Should Jacqueline and Keith close the 2.75%, 15-year mort­gage? Use 2.15% money market return as the opportunity cost. Explain your answer with suitable calculations.

Answer rating: 100% (QA)

SOLUTION To determine whether Jacqueline and Keith should close the 275 15year mortgage we need to compare the present value of the cash flows from their current 30year mortgage to the present value o... View the full answer