A household purchased a house 5 years ago for $450,000. The purchase was financed with a 30 year 4% Fixed Rate loan at an LTV of 90%. The household has the option of refinancing the outstanding principal with a 10 year 3% Adjustable Rate Mortgage Loan. What are the advantages and disadvantages to the refinancing alternative?

Answer:

Formula Used:-

Annual Payments=PMT(P52,P51,-P50)

Balance after 5 years=FV(P52,5,P53,-P50)

Annual Payments=PMT(P56,P55,-P54)

Advantages:-

1. Reduces overall cost of borrowing
2. Reduces total payment of loan
3. Reduces amount of interest to be paid.

Disadvantage:-

1. Increase in annual installment
2. Many financial institutions requires pre-payment penalties so it may nullify the interest saving
3. A person with limited resources may not able to afford the huge payments

Answer: