Question

You are buying a $350,000 home and are deciding between two fixed rate mortgage options. The 80% LTV option has an interest rate of 6% over 30 years. The 90% LTV option has an interest rate of 6.5% over 30 years with 2 discount points.

• What is the incremental borrowing cost when choosing the 90% LTV option over the 80% LTV option?

• Why is the effective borrowing cost higher for the 90% LTV option?

Answer 1

Incremental borrowing cost when choosing the 90% LTV option over the 80% LTV option= 0.695%

Calculations given below.

Effective cost is higher for 90% LTV option because of the following:

(I ): Interest rate is higher by 0.5%

(ii ): This option has discount points which reduces the net amount received, while the monthly payments including interest are based on the loan amount before reducing by the points. In the 80% LTV option, there is no points and hence effective borrowing is equal to the amount on which interest is applied for payment.