Question

Rachel and Tom Baker are your friends with whom you have attended the same Bible study for several years. You are a mortgage originator for the XYZ Mortgage Brokerage, Inc., and the Bakers have come to you for advice concerning the possibility of refinancing their existing mortgage. Their current 30-year, fixed rate mortgage was originally issued for $300,000 at a rate of 6.000%. They have owned their home for 15 years and their current mortgage balance is $213,150. You have identified the following mortgage options for the Bakers:

•           30-Year Fixed Rate; 5.125%; $1,000 cash required at closing

•           15-Year Fixed Rate; 4.500%; $5,000 cash required at closing

•           5/1 ARM; 4.375% (2% cap per year; 10% life); $4,500 cash required at closing

The owner of XYZ has been particularly vocal about the need to maximize profits for the firm given the continued lag in the real estate market. Your firm stands to collect the following fees (including fees paid by the mortgage lender directly to your company) associated with each of the mortgage options, as follows:

•           30-Year Fixed Rate – $4,000

•           15-Year Fixed Rate – $3,750

•           5/1 ARM – $4,250

As a principled Christian, you are guided by your desire to provide the excellent service to your customers but, of course, you must also make money for your employer and for yourself (your salary is 100% commission-based). In reviewing the Bakers’ financial situation, you find that their credit ratings are very high and that they are well qualified to refinance their mortgage at the most favorable rates available.

• What advice will you give to the Bakers concerning their interest in refinancing their existing mortgage? Explain your recommendation.
• Evaluate the risk-return trade-off for each option and justify your advice with financial calculations and logical and ethical considerations.

Answer 1

OPTION 1: 30 year Fixed Rate; 5.125%; $1,000 cash required at closing

The Monthly Repayments would be $1,633.46

The sum of all monthly repayments over a period of 30 years would be $588,045.60

OPTION 2: 15 year Fixed Rate; 4.5%; $5,000 cash required at closing

The Monthly Repayments would be $2,294.98

The sum of all monthly repayments over a period of 15 years would be $413,096.40

OPTION 3: 5/1 ARM, 4.357% (2% cap per year; 10% life), $4,500 cash required at closing

The Monthly Repayments would be $1,089.25

The sum of all monthly repayments over a period of 30 years would be $392,130.00

RECOMMENDATION

On a comparison of the above three options, we are able to recommend that Option 3 would be the best suited for Bakers and the reason for the same are as below:

1. The Monthly Interest payments are the lowest among the three options
2. The Overall total repayment over the mortgage term also works out to be the lowest.
3. The Commission received by XYZ Mortgage Brokerage Inc. and the corresponding commission received by the recommender is also the highest in this case.

So Option 3 is the best suited for Rachel & Tom Baker.