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Other Possibilities
In addition to using the Profit/Loss formulas to evaluate loan types, you can also use them to better understand options available to you within a particular type of loan.
We've already seen how the formulas apply to variations within fixed-rate loans, when we discussed how the 15-year, fixed-rate loan compared to its 30-year, fixed-rate cousin.
Another variation on loans is the payment of points.
A point is an fee that a mortage company charges you when you take out your loan. A "point" is an amount equal to 1 percent of your loan amount. And the money can be used for the administrative costs incurred to process your loan. It also can be used to lower the interest-rate on your loan.
Here's how points are used to reduce the interest rate on your loan. According to the Pay Me Now or Pay Me Later formula, a mortgage company is willing to take lower profits early in a loan for greater profits later. They are also willing to take greater profits now for lower profits later. So if you are willing (and able) to pay additional money at the start of your loan in the form of points, the mortgage company gives up some of its later profits (from higher interest rates) by taking early profits (in the form of points). Since you are willing to pay more now, you get to pay less later.
This early payment also represents reduced risk for the mortgage company. Any money they collect up front eliminates the risk that it cannot be collected later. Therefore, the reduced risk further enhances their willingness to lower your interest rate.
Wrapping It Up
The variations that exist in how mortages can be structured are endless. Deciding which loan will work best for your situation can be daunting. The myriad of possibilities make it very difficult to chart your course through the mortgage jungle. And the loan that your loan rep most strongly pushes may not be the proper loan for you. Fortunately, having a basic understanding of the factors that drive how a mortgage company creates its loan products can help you find a mortgage that fits your needs. This understanding can help you decide if your loan rep has a loan that is suitable for you, or if you should look elsewhere.
The Profit/Risk formulas provide important insight into how a mortgage company "thinks." They also act as tools to help you better understand the costs and risks associated with a particular loan. By analyzing your loan in light of the principles of the Profit/Risk formulas, you can gain a good sense of the tradeoffs between early mortgage costs as compared to later mortgage costs, and how much risk is involved with various options.
Having a clearer view of costs and risks enables you to manage your loan in a way that will increase your odds of achieving your financial goals -- the lowest costs at an acceptable level of risk. My hope is that you are able to use this information effectively and avoid financial disaster.
Information You Should Know: The author is not affiliated with any banking or financial institution or organization, nor is the author affiliated with any of the companies that may display advertisments with this article. The information provided here is believed to be accurate; reasonable attempts have been made to ensure its accuracy. However, it is provided "as is"; no guarantee is made regarding its accuracy. Please consult your financial consultant for any questions you may have regarding your unique situation.
