Modified Midterm 2 Points Question

For questions 1-3 consider the following mortgage terms for a standard US mortgage:

Option A: 8% No points
Option B: 7% , four points

1. Consider a \$350,000.00 loan. What would the monthly payments be if you took the
loan with no points, i.e., option A?

(a) \$ 25,086.92
(b) \$ 3,105.28
(c) \$2,568.17
(d) None of the above.

Solution:

First we need to calculate the effective interest rate. The loan is 8% compounded monthly so EIR = 0.08/12 =0.006667. Since it is a standard US mortgage we have N = 30*12= 360 payments. Using factor notation the monthly payments are A = \$350,000(A\P, 0.006667, 360) = \$2,568.17.

The answer is c.

2. Consider the same \$ 350,000.00 loan. What would your monthly payments be if you
took the loan with points, i.e., option B?

(a) \$ 2,421.70
(b) \$ 2,505.1
(c) \$ 2,345.67
(d) \$ 2,608.01

Solution:

Using N=360 i = 0.07/12, Points = 4, and P = \$350,000, the monthly payment with points is:

A = Principle(1+Points)(A|P,i,N) = \$350,000(1+0.04)(A|P, 0.07/12, 360) = \$2,421.70.

The answer is a.

3. Suppose you plan on keeping the home for 10 years. Should you take the points?

(a) Yes
(b) No
(c) Neither a or b

Solution:

By paying four points (\$14,000), you save \$146.74 per month on your payment. It will take you approximately 96 months (about 8 years) before the amount saved is greater than the cost of the four points. Since you plan on keeping the home for 10 years you should take the points.

The answer is a.

page revision: 3, last edited: 20 May 2010 03:44