McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER4CHAPTER4 CHAPTER4CHAPTER4 Fixed Rate Mortgage Loans: Part 2

4-2 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Closing Costs Statutory  Transfer  Recording Fees etc. Third Party Charges  Appraisals  Surveys  Inspections, etc.

4-3 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Closing Costs

4-4 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Closing Costs Additional Finance Charges  Loan Origination Fees Cover origination expenses  Loan Discount Fees – “Points” Used to raise the yield on the loan Borrower trade-off: points vs. contract rate 1 Point = 1% of the loan amount

4-5 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Closing Costs Why Points?  Sticky mortgage rates  Price in the risk of a borrower  Early repayment of a loan does not allow recovery of origination costs  Earn a profit on loans sold to investors at a yield equal to the loan interest rate.

4-6 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Fees & Borrowing Costs Calculating the effective interest cost Example 4-2:  $250,000 home  80% LTV Loan  8% Interest  4 Points  30 Years

4-7 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Fees & Borrowing Costs Step 1: Compute payment using the face value of the loan. = $200,000 = 360 = 8 = $ But, with points paid up front, the borrower actually receives less than the face value. n i PMT PV

4-8 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Fees & Borrowing Costs Step 2: Loan Amount = $200,000 - Points Paid = (.04 x $200,000) Amount Received = $192,000 Compute effective interest cost, using the Amount Received from Step 2 & Payment from Step 1.

4-9 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Fees & Borrowing Costs Compute effective interest cost: = $192,000= $ = 360= 8.44% PMTPV nCPT i

4-10 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Fees & Borrowing Costs What is the effective cost if we think this loan might be repaid after 8 years?  Step 1: Compute PMT = $  Step 2: Compute Future Loan Balance P1 = 1 P2 = 96 Balance = $182, ENTER AMORT ↓ ENTER ↓

4-11 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Loan Fees & Borrowing Costs  Step 3: Compute effective interest cost. = ($192,000) = $182, = $ = 96 = 8.72% n i CPT FV PMT PV

4-12 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Example A borrower is faced with choosing between two loans. Loan A is available for $75,000 at 10% for 30 years with 6 points. Loan B would be made for the same amount, but for 11% interest for 30 years with 2 points. Both loans are fully amortizing.  If the loan is repaid after 15 years, what is the better choice?  If the loan is repaid after 5 years, what is the better choice?