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(solution) Problem 1 . A real estate owner needs $10 million mortgage for


Problem 1. A real estate owner needs $10 million mortgage for five years. After talking to a few commercial mortgage lenders, you have narrowed down to the following three choices. 

The owner will choose the loan with the lowest effective yield.

 

1) Please draw cash flow chart and compute the effective yield for each loan. 

2) Please rank the three loans. Which loan the owner will choose? 


Loan 1: An interest only loan with 10% fixed rate for 3 years and extend for 2 more years with 1 point extension fee and with floating rate (assuming the interest rates for year 4 and 5 are 11.5% and 12% respectively).  The underwriting fee is 3% of the loan amount. 


Loan 2: An interest only loan with five year term and 11% interest rate fixed for the 5 years. The underwriting fee is 3% of the loan amount.


Loan 3: A fixed rate mortgage with 11% interest rate, five year maturity and 30 year amortization (partial amortization). The underwriting fee is 2% of the loan amount.

 


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