Unexpectedly Intriguing!
October 15, 2007

Calculator Via Greg Mankiw, we find that the National Bureau of Economic Research has stormed onto our turf by launching a tool based on recent economic research into when people should refinance by exchanging their old fixed-rate mortgage with a new one!

What It Does

The tool is based on an NBER paper by Sumit Agarwal, John Driscoll and David Laibson, which develops a mathematical solution for determining the optimal interest rate threshold for which a homeowner should refinance their mortgage.

In finding the fixed interest rate at which a homeowner should refinance, the tool factors in such considerations as how much money is current owed on the existing mortgage, how much time is left for the mortgage to be paid off, its interest rate, the homeowner's income tax bracket, how long the homeowner expects to remain in the house and the points and closing costs for the new mortgage.

Beyond these basic factors, an advanced section of parameters also allows users to incorporate factors such as their personal discount rate for future costs, the average rate of inflation and the annualized standard deviation for mortgage interest rates. Most tool users won't need to adjust these figures, but might consider doing so to better reflect their expectations and their mortgage market.

In return for entering all this data, the tool determines the highest interest rate for a new fixed-rate mortgage for which a homeowner would benefit by refinancing. If a new fixed-rate mortgage available to a homeowner has a lower interest rate, their decision to refinance would become even more beneficial.

The User Interface

The user interface for entering data in the tool is straightforward, but slightly clunky as the tool's designer opted to minimize the amount of vertical scrolling that a user might have to do by using a split-table design. The good news here is that most users will only use the left-half of the user input (covering the basic factors), and will simply ignore the right half (the advanced factors).

NBER Optimal Mortgage Rate Tool Interface

This raises an obvious question: since most people who would benefit from using the tool won't be changing these factors, why bother including this part of the user interface for them?

From our long experience in putting tools on the web, we find that including this advanced section is a smart thing to do. The reason why is that it allows others who might have a very different set of assumptions about their economic environment to incorporate them into the tool's calculations, making it more useful for a broader range of situations (such as might differ from those in the U.S.) Including this section also has the side benefit of increasing the credibility of the math behind the tool, which is not a small thing to take for granted, particularly in the area of what future cost discount rate might be appropriate to consider.

Where the NBER tool falls short however is in what happens after a user clicks the "Calculate Optimal Mortgage Rate" text button. Rather than simply providing an output data field directly on the tool's interface, the tool's web page refreshes and provides the result above the input data fields.

This approach has several shortcomings. First, from the user perspective, it creates a delay as the entire page must be regenerated on their web browser. This delay may vary for several factors, such as the user's bandwidth (speed of Internet connection) and the NBER's server load (how busy the computers are where the calculations are run). As we ran the tool, we experienced a delay of several seconds while waiting for the page to refresh.

Second, from the NBER's computer administrator's perspective, it's a taxing approach for providing a relatively simple calculation. The tool's interface must be fully transmitted at least two times, not to mention the computing resources that must be consumed for just running the calculations.

This isn't a big deal if only a handful of people choose to do so at one time or if the NBER's server has ample capacity and bandwidth available to it, but this can bog down the entire server's performance if a large volume of people choose to run their numbers at one time or if the server's bandwidth and capacity are lacking.

The Bottom Line

While the presentation of its results might be substantially improved, the NBER's tool for finding the optimal interest rate at which to refinance a fixed rate mortgage is a highly useful resource. If you're thinking about refinancing, use it!

Previously on Political Calculations

We're not idle spectators when it comes to considering refinancing or the tools that you can use to find answers you might want to know! Here's our short list of our tools and the questions we've tackled in this area:

Refinancing: Time to Break Even

How many months will it take to make back the money it cost to refinance your loan?

Refinancing: How Much Will You Save in the Long Run?

How much will keeping your loan cost over its remaining life if you leave it as it is? And how much will your refinanced loan cost over its full term?

Does Home Loan Consolidation Make Sense?

If you have a mortage *and* a line-of-credit that taps the value of your home's equity, would it make sense to considate both kinds of debt into a single loan?

How Much Equity Is in Your Home?

If you're looking to tap the value of your home to refinance your debt, our tool will help you figure out how much equity you've accumulated!

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