When to Refinance Mortgage Loans in a Stochastic Interest Rate Environment

Refinancing refers to the replacement of an existing debt obligation with another debt obligation to take the advantage of a lower interest rate. This paper reflects our ongoing work to find a desirable refinancing time for mortgage borrowers to minimize the total payments in a dynamic interest rate environment. To simulate the alternative financial service that the market may offer, it is assumed that the future interest rate follows a stochastic model with mean-reverting property, which is essentially the only required market condition to implement our method. To make it more applicable to the real financial practice, two balance settlement schemes are considered and compared. Numerical simulations with varying samplings lead to several interesting characteristics pertaining to the optimal mortgage refinancing period. Our method is robust and user friendly, thus is useful for financial institutions and individual property investors.