Question 1

For various reasons a buyer wishes to purchase this mortgage cash flow for the next 36 months but wants a yield of 7% instead of 11%. The buyer would purchase the 36 months of cash flow for $166,085.08 instead of $150,000 thus paying a premium of $16,085.08.

Question 2

A builder is having difficulty selling his $150,000 homes at 11% so he does a buydown calculation to make the homes more attractive. He raises the selling price to $166,085.08 and offers 7% mortgages. The builder gets the same return on investment and the new buyer thinks he is getting a great interest rate.

Question 3

A borrower has a current balance of $150,000 on his mortgage and is paying 11% but current rates have dropped dramatically for a three year term and the borrower wants out of the contract so that he can enjoy the low rates of 7%. This is a common situation in Canada. The lender asks the borrower to pay the “penalty” of $16,085.08 and charges only 7% interest for the remaining 36 months. The lender gets the exact same yield on the mortgage and the borrower changes four quarters for a dollar and is happy. In Canada this is called the IRD calculation, Interest Rate Differential calculation.