When buying a home mortgage, you often have the option of paying some money in advance (called “discount points”) to get a lower interest rate. Assume that you have the choice between two 15-year mortgages: one at 8%,and the other at 7 3 4% with an up-front charge of 1% of the mortgage value. How long would it take to recover the 1% charge when you take the mort- gage at the lower rate? As a second, more precise estimate, how long would it take to recover the charge plus the interest you would have received if you had invested the equivalent of the 1% charge in the bank at 5% interest while paying the higher rate? DO NOT use a calculator to help you answer this question.
When you build a new house, you sometimes get a “construction loan” which is a temporary line of credit out of which you pay construction costs as they occur. At the end of the construction period, you then replace the construction loan with a regular mortgage on the house. During the construction loan, you only pay each month for the interest charged against the actual amount
borrowed so far. Assume that your house construction project starts at the beginning of April, and is complete at the end of six months. Assume that the total construction cost will be $300,000 with the costs occurring at the be- ginning of each month in $50,000 increments. The construction loan charges 6% interest. Estimate the total interest payments that must be paid over the life of the construction loan.
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