You Are Purchasing a New Home and Need to Borrow

question 27

Essay

You are purchasing a new home and need to borrow $325,000 from a mortgage lender. The mortgage lender quotes you a rate of 6.5% APR for a 30-year fixed rate mortgage (with payments made at the end of each month). The mortgage lender also tells you that if you are willing to pay one point, they can offer you a lower rate of 6.25% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points, you will need to borrow an additional $3,250 to cover points you are paying the lender. Assuming that you do not intend to prepay your mortgage (pay off your mortgage early), are you better off paying the one point and borrowing at 6.25% APR or just taking out the loan at 6.5% without any points?

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Definitions:

Private Consumption

The total value of all goods and services consumed by private households.

Pareto Efficient

An economic state where resources are allocated in a way that it is impossible to make any one individual better off without making at least one individual worse off.

Public Good

A commodity or service that is provided without profit to all members of a society, either by the government or a private individual or organization.

Private Good

An economic product or service that is consumed by an individual or a specific group, characterized by its exclusivity and rivalry in consumption.