Points raise the rate and front-load the yield curve in favor of the lender
Yield curve: 30-year loan, 8.00 APR + 2 points
APR is not a yield.
APR understates the
cost of a points loan even if the loan runs to
term (30 years).
The term of the average
mortgage is thought to be 6 to 7 years. Banks
guard average loan-length info zealously.
How points work
A "point" is a 1% discount on a loan - TO THE LENDER
"Nominal" means "in name
The rate disclosure on a points
loan is twice bent:
1. APR is a nominal rate.
2. The amount loaned is a nominal amount.
From the lender's point of view:
The points received reduce the amount the bank
has to borrow from depositors to make the loan.
The bank's borrowing is the nominal amount of
the loan minus points paid.
From the borrower's point of view:
The borrower is partly borrowing his own money
(the points paid) and paying the APY for the
privilege. The amount to be repaid is the nominal
amount of the loan. But the net proceeds
of the loan is the nominal amount of the loan
minus points paid.
E. g: If you start with $2,000 cash, and you
pay 2 points to the lender to receive a
$100,000 loan, you're only $98,000 ahead of
your pre-loan cash position after receiving the
loan. You don't even need the cash upfront
according to Official Opinion, "The
rule in footnote 33 applies even if the loan
fee, points, or similar charges are billed on a
subsequent periodic statement or
withheld from the proceeds of the first
advance on the account." You repay the
full $100,000 at the APR.
Points create a declining-rate loan with much higher
rates in the early years. Points raise the APY and skew
the yield curve. Many points loans are paid off
early, considerably raising the rate on those loans.
Points create a "What you see is not what you
get" rate disclosure.
A discounted cash flow analysis will reveal the
interest rate curve of a points loan.
Discounted cash flow analysis - to Yield (the lender's view)
APR is only the Truth-in-Lending
required disclosure, not the yield
to the lender. There is a difference.
Download (Rt-click, Save As) filetype for your spreadsheet:
Excel 5 w/chart (above) in log time
Lotus 97 w/chart in log time
Lotus 2.2 (DOS) w/chart in log time
M$ Works 4.5a w/chart in log time
Initial loan amount 100000.00
Interest, APR 8.00 Input tables vary between
Points 2.00 spreadsheets to implement
Term, months 360.00 active chart labeling.
===== Computer calculates =======
PMT (Mo.) 733.76
Yield on APR b4 Pts 8.30
Net loan after Points 98000.00
Table truncated for online viewing
Years to refinancing = 1 2 3 [...]
YIELD = 100*((1+irr)^12-1) = 10.60 9.50 9.13
IRR (pPR, monthly) = 0.008433 0.007589 0.007308
Initialize loan 0 -98000.00 -98000.00 -98000.00
Payment # 1 733.76 733.76 733.76
2 733.76 733.76 733.76
3 733.76 733.76 733.76
4 733.76 733.76 733.76
5 733.76 733.76 733.76
6 733.76 733.76 733.76
7 733.76 733.76 733.76