Ann buys a property that costs 1000000 she finances the...

"Ann buys a property that costs $1,000,000. She finances the purchase with a 70% LTV mortgage. She gets a 20 year interest only fixed rate mortgage at an annual interest rate of 5%, with annual compounding and annual payments. Ann must pay 2 points upfront in mortgage closing costs (as a % of the loan amount). The loan has a 5/4/3/2/1 prepayment penalty structure (she must pay a 5% penalty if she prepays at any time in the first year, 4% penalty in the second year etc). Suppose Ann will sell the property in 3 years, after her 3rd year s mortgage payment and pay off the balance when she sells. What is Ann s annualized IRR for the loan? "

Transcript

00:01 Hello students to calculate ann's annualized internal rate of return that is irr for the loan we need to consider the cash flow flows associated with the mortgage.

00:12 So first loan amount equal to ann finances 70 % of the property's cost which is 10 lakh dollar into 0 .7 that is 7 lakh.

00:45 7 lakh upfront mortgage closing cost and pays 2 points upfront as a percentage of the loan amount which is 2 % so 2 % into 7 lakh is equal to $14 ,000 annual interest payment.

01:33 Ann has an interest only mortgage for 20 years at an annual interest rate of 5 % so the annual interest payment is 7 lakh dollar into 0 .05 that is 35 ,000 per dollar per year.

01:55 Now prepayment penalty prepayment penalty if ann sells the property after 3 years she will incur 3 % prepayment penalty on the remaining loan balance 3 % prepayment penalty on the remaining loan balance to calculate ann's annualized irr we need to determine the cash flows for the each year then find the discount rate that equates the present value of this flows to 0.

02:52 So for the year 1 year interest payment prepayment penalty for year 1 investment is $35 ,000 and prepayment penalty is equal to 0.

03:26 For year 2 investment is also $35 ,000 and prepayment penalty is equal to 0.

03:36 For year 3 investment is equal to $35 ,000 and prepayment penalty is 3 % of the remaining loan balance at the time of sale.

03:49 To find the remaining loan balance in the year 3 we calculate the annual interest payment for year 4 and subtract it from the remaining balance in 4.

03:59 So in year 4 the interest amount is also $35 ,000...

Question

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