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.

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.

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.