Points Front-Load the Yield Curve and Raise The Rate
Chart: yield curve for a 30-year loan at APR=8.00 + 2 points
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a) APR is not a yield.
b) APR understates the cost of a points loan even if the loan runs to term (30 years). c) The term of the average mortgage loan is thought to be 6 to 7 years. Banks guard this info zealously. |
The Slippery Slope: How Points Work:
A ''point'' is a 1% discount on a loan, to the lender.
The rate disclosure on a points loan is twice bent:1. APR is a ''nominal'' rate.
When is a rate not a true rate? When it's a ''nominal'' rate.2. The amount loaned is a nominal amount.
''Nominal'' means ''in name only.''
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 APR 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 Reg Z's '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.
''WYSIWIG'' rate disclosure . . . in reverse:
Points create a ''What you see is not what you get'' rate disclosure.Points create a declining-rate loan with much higher rates in the early years. Points permanently raise the APY even if the loan goes to term. Points loans, like other loans, are often paid off early (refinancing is a payoff), effectively raising the APR on those loans above the quoted APR.
A discounted cash flow analysis will reveal the interest rate curve of a points loan.
Points' spreadsheet:
The spreadsheet provides a discounted cash flow analysis to yield, from the lender's point-of-view.APR is only the Truth-in-Lending required disclosure,
not the yield to the lender. There is a difference.
Download the filetype for your spreadsheet,
(with chart in log time like at the top of this page):
Here's a portion of a typical spreadsheet:
| INPUTS: | Note: | ||||
|---|---|---|---|---|---|
| Initial loan amount | 100000.00 | Input tables vary | |||
| Interest, APR | 8.00 | between spreadsheets | |||
| Points | 2.00 | to implement active | |||
| Term, months | 360.00 | chart labeling. | |||
| Computer calculates: | |||||
| PMT (Mo.) | 733.76 | ||||
| Yield on APR b4 Pts | 8.30 | ||||
| Net loan after Points | 98000.00 | ||||
| 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 | ||
| [...] | |||||
