Lecture_400X_ResidFin

# Lecture_400X_ResidFin - Additional Topics in Borrowing...

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Additional Topics in Borrowing Residential Mortgage Analysis

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I. Comparing two loans with different terms: The incremental cost of borrowing AKA: The marginal cost of borrowing or The marginal cost of additional funds Consider: Loan A: \$80,000 for 25 years at 12% Loan B: \$90,000 for 25 years at 13% What is the cost of acquiring the extra \$10,000?
The answer is not 13%. Why? To compare… Step 1: Calculate the difference in monthly payments for the two loans. Step 2: Find the effective yield, assuming that difference in payments is used to pay down the extra \$10,000 over 25 years (as a separate loan)

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We can think of the 13% rate as a weighted average of the 12% rate on the first \$80,000 and the 20.57% on the additional \$10,000 What might we want to do instead of getting the \$90K loan at the 13% rate if we really need the \$90K? What if we expect to repay our loan before the 25 year maturity?
We solve for I/YR given: PV = \$10,000 (diff in loan amount) PMT = -\$172.47 (diff in PMT) N = 60 FV = -\$10,117.32 (diff in OLB after 5 years) I/YR = 20.83% What if points are charged on either or both of the loans?

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Rules of thumb: The incremental cost of borrowing increases with the difference in the contracted interest rates. But also… The incremental cost of borrowing should
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## This note was uploaded on 06/08/2011 for the course BUAD 400x at USC.

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Lecture_400X_ResidFin - Additional Topics in Borrowing...

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