Two mortgage options are available: a 30-year fixed-rate loan at 6% with no discount points, and a 30-year fixed-rate loan at 5.75% with points. If you are planning on living in the house for 12 years, what is the most you are willing to pay in points for the 5.75% mortgage? Assume a $100,000 mortgage.
Note that the solution below is per the text. It is wrong. It is wrong because it only considers the payments for the first 12 years and ignores the balance at the end of 12 years. The balance on the 5.75% loan will be lower at the end of 12 years because a larger portion of the payments for the first 12 years get applied to principal pay-down. That is always true at a lower rate. The authors tried to make the problem fit a financial calculator easily. You should model a problem like this in Excel to properly solve it. In fact, this is a good problem for Solver. You could find the discount points level that makes the yield for the two alternatives equal.