All financial calculators have buttons you push to discover various financial factors. These buttons are labeled N for the number of payments until a loan is fully paid off; I for the rate of interest being paid in each payment period; and PMT for the amount money paid for interest and principal. FV stands for the future value of the sums being paid. A very important button is labled PV for Present Value. Many creative financial formulas take P.V. into consideration. What is Present Value? Let me see if I can explain it to you:
Somehow, money that is received right away is more valuable than money that will be received later. How much more valuable like beauty lies in the eyes of the recipient, but absent of a pressing need for the money, financial mathematicians have come up with a term that expresses the difference between now and later. It is called Present Value.
When the Present Value is contrasted with the value of the money paid at a future time (Future Value), a difference in value can be calculated and that in turn can be related to the yield that the person who is paying later might realize, albeit it may be intangible.
For some reason, many people refuse to take the time to learn how to figure out how to use a calculator, even though knowing a few simple techniques can make the difference of thousands of dollars on a single deal. Here’s why:
By learning how to manipulate these buttons, it is possible to discover how much the rate of interest is, the number of payments until a loan is paid off, the amount of money still to be paid on an existing loan and the remaining unpaid balance; and the amount of money your money would earn if you loaned it for a set period of time, with a set payment, until it was completely paid off. Can you see how this might be of value to you?
For example, which would be better for me: Buying a house with a $125,000 secured Note which called for no interest for ten years, at which time $125,000 would be due and payable in a lump sum? Or, buying the same house for $100,000 with a Note calling for 120 monthly payments of $1213.28 including 8% annual interest? To figure out which offer would be best for the buyer, he would have to compare these two methods of payment to discover the PV.
The PV of the single payment, zero interest note would be equal to the sum of $125,000 discounted at the same rate as the other alternative, or .67% per month, for 120 months. The PV of this loan would be $56,315.43. Hold that thought a moment.
If you multiplied out all the monthly payments on the more conventional Note, you’d wind up paying $145,533.11. The difference in cost to you would be $89, 271.68. Now does learning how to calculate PV seem of any value to you.
Can you see why I’ll let the seller have his price almost all of the time without a murmur if I can get as financing terms a single payment, zero interest Note?
Thanks to Texas Loan Officer, Bill Bodwell, for pointing out a common error of not comparing the two income streams in the same time period. I agree completely with him, that to be able to make an accurate comparison, I should only compare Present Value of the deferred payments with Present Value of the Income Stream. In this instance the savings would still have been significant; however, if the income stream's interest rate had been lower, it could have drastically reduced the advantage in the single payment Note. That's why it's important to compare apples to apples; in this instance, $100,000 with $56,315.43.
