Ms. Smith owns a house, which she purchased five years ago. The original mortgage was for $150,000 with an interest rate of 8% and a term of 25 years. She also paid 2 points. Interest rates have now fallen to 6% and a new mortgage can be obtained for an origination fee of 1% of the new loan amount. The term is 20 years. If the existing loan is paid off within 10 years of origination, a prepayment penalty equal to 1.5% of the outstanding balance will be charged. a) Should Ms. Smith refinance her mortgage if she plans to sell the house 5 years from now and her required rate of return is 8%? Assume that the new loan amount would be equal to the outstanding balance of the loan.
b) Approximately how long must Ms. Smith hold the new mortgage for in order to recover her initial investment?