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Copyright © 2002, Joel Anderson

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

Yield curve: 8.00 APR + 2 points (Excel5 chart) 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 only."

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.


Points' spreadsheet

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

              INPUTS:
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
                              Month
      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
                            [...]