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Additional Topics in Borrowing
Residential Mortgage Analysis
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View Full Document 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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View Full Document 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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View Full Document 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.
 '10
 SESLEN,TRACY
 Finance

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