Question
A year ago ABCD originated four balloon mortgages, each having a face value of $500,000. The four mortgages loans mentioned above are identical in their
A year ago ABCD originated four balloon mortgages, each having a face value of $500,000. The four mortgages loans mentioned above are identical in their features and they all came from the same market area. The mortgages have an original amortization period of 25 years (300 months) with monthly payments. However, the original term-to-maturity of the mortgages is 11 years (132 months), which means that the outstanding loan amount of each mortgage is due at the end of the 11th year making them balloon mortgages. The prevailing market interest rate for such loans at the time the mortgages were originated was 8%. However, instead of charging the market interest rate, the Senior VP for mortgage finance, priced each mortgage loan with a combination of 7% contract interest rate and 5 discount points. The discount points were paid up-front by the borrowers at the time of origination. There is no prepayment penalty. The market interest rate now (a year after origination) for similar mortgages is 8.5% and ABCD is conducting post origination audit of its mortgage portfolio
Question: Although borrowers normally pay discount points upfront at origination time, your boss is curious to know what the EIR would had ABCD chosen to roll the points into the face value of loan (i.e. finance the points together with the loan amount requested by the borrowing. That is the lender funds the loans as well as finances the points. In conducting this analysis determine the EIR or APR on the loans and Annualized Effective Yield assuming ABCD finances the points rather than deducting the points upfront. Is ABCD better off or worse off using this strategy compared to the original strategy of charging discount points upfront?
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