In 1994, I purchased my first house – hard to believe that was over 20 years ago. And although it was exciting, the thing that I remember most about that house was a conversation with the lender about the mortgage. I know – I have issues, but those that were around the real estate biz back then may remember how mortgage rates were at “historical lows.” And at 7.75%, my rate was indeed attractive (at least for those days).
But my conversation with the lender was focused on a concept known as “points.” If I were willing to pay two points at the time the loan is originated, an amount equal to 2% of the initial loan amount, the interest rate associated with the loan would be lowered to 7.5%. At the time, I didn’t have enough of a technical grasp to determine the exact impact of this, so I made a snap decision. But now I do – and in a few minutes, so will you.
Analyzing the impact of points can be done using a T-bar and following three simple steps. You may recall that a T-bar is a tool developed by the CCIM Institute to help visualize time and money. As shown in Figure A , time is shown on the left side of the T and represented by N. Flows of money are shown on the right side of the T and include present value (PV), periodic payments (PMT) and future value (FV). To help walk through this, let’s go in the way-back machine and analyze the alternatives that I faced in 1994. My loan was for $100,000, amortized over 30 years with monthly payments. The interest rate choices were 7.75% with no points and 7.5 % with two points. For reasons that will be apparent in a few minutes, the analysis will only focus on the loan with points. Link to full article.