Mortgages and Refinancing

TL;DR

This paper develops a synthetic mortgage calculator considering refinancing costs, models interest rate effects on mortgage risk, and analyzes impacts on swap and treasury bond markets using stochastic interest rates.

Contribution

It introduces a comprehensive mortgage refinancing model that incorporates costs and interest rate risks, with applications to financial markets.

Findings

Refinancing effects depend on underlying costs and interest rate shifts.

Negative duration risk is significant for mortgage issuers.

Interest rate modeling impacts on swap and treasury markets.

Abstract

In general, homeowners refinance in response to a decrease in interest rates, as their borrowing costs are lowered. However, it is worth investigating the effects of refinancing after taking the underlying costs into consideration. Here we develop a synthetic mortgage calculator that sufficiently accounts for such costs and the implications on new monthly payments. To confirm the accuracy of the calculator, we simulate the effects of refinancing over 15 and 30 year periods. We then model the effects of refinancing as risk to the issuer of the mortgage, as there is negative duration associated with shifts in the interest rate. Furthermore, we investigate the effects on the swap market as well as the treasury bond market. We model stochastic interest rates using the Vasicek model.