When Should Borrowers Refinance Their Mortgages?

rates that are very close to their original mortgage interest rate than we are to observe mortgage holders who have the opportunity to refinance at larger

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When Should Borrowers Refinance Their Mortgages?
We develop an analytically tractable option pricing model of a mortgage holder’s optimal refinancing behavior. This reduces to the choice of an optimal interest rate differential. At this optimal differential, the value of the interest saved equals the sum of refinancing costs and the difference between the old in the money refinancing option that is implicitly given up at the refinancing and the new out of the money refinancing option that is implicitly acquired. For a reasonable range of parameter values, we calculate the differential to be bounded below by 100 basis points. Using a unique panel data set from a large financial institution, we find that during the 1990s over half of refinancers did so at differentials of 100 basis points or fewer.

Download When Should Borrowers Refinance Their Mortgages? pdf from www.ssc.wisc.edu, 23 pages, 361.38KB.
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