Discount Points, Effective Yields and Mortgage Prepayments
Lenders use discount points to vary effective yields from stated contract rates. In the past, this practice resulted from interest-rate regulation. In market, however, there seems to be an absence of economic rationale as to how points are applied in individual cases. This paper provides an economic rationale for the use of points. An option pricing model is used to derive some basic rules for determining the relationship between changes in the contract rate and the payment of points. This explains current practices by lenders in that the option value effect could justify a reduction in the contract rate of well over one-eighth of a percent and shows that lenders are justified in varying the size of the trade-off between points and contract rates based on risk of prepayment. Lenders must charge a premium for providing the prepayment option; however, the payment of points provides a means whereby this call provision can be retained but reduced in value to suit the preferences of individual borrowers.
Volume (Year): 2 (1987)
Issue (Month): 2 ()
|Contact details of provider:|| Postal: |
Web page: http://www.aresnet.org/
|Order Information:|| Postal: Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323|
Web: http://pages.jh.edu/jrer/about/get.htm Email:
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Patric H. Hendershott & Robert Van Order, 1987. "Pricing Mortgages: An Interpretation of the Models and Results," NBER Working Papers 2290, National Bureau of Economic Research, Inc.
- Patric H. Hendershott & Sheng Cheng Hu & Kevin E. Villani, 1982. "The Economics of Mortgage Terminations: Implications for Mortgage Lenders and Mortgage Terms," NBER Working Papers 0918, National Bureau of Economic Research, Inc.
- Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
When requesting a correction, please mention this item's handle: RePEc:jre:issued:v:2:n:2:1987:p:97-104. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (JRER Graduate Assistant/Webmaster)
If references are entirely missing, you can add them using this form.