Harvard Business Review- Revere St

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For Alexander to purchase this piece of property, he needs to choose between two different sources of funding. Both of these options are based on a 20 year, 8 percent rate. Alexander has $80,000 of his own equity to invest in the project, a very small portion of the total capital investment.

The first option that Alexander has is through a savings bank, transferring the mortgage from seller to buyer. The mortgages account for $400,000, bringing the total investment including Alexander’s contributions to $480,000. Expenses already incurred include mortgage origination fees and legal expenses, which are not included in the closing costs, which include the price of the property, bank fees, and $375,000 in escrow. After accounting for these calculations for remodeling, there is a $60,000 gap required to be paid from the initial $165,000. In addition to this large sum of money, this particular mortgage is loaned in stages, minimizing the cash flow available to account for closing costs.

Another mortgage option is a $450,000 loan from an alternate local savings bank. Again, Alexander will commit $80,000 from his own accounts, totaling $530,000 for the project. Closing costs for carry construction costs bank legal fees, mortgage origination, and legal expenses total $384,000, almost $10,000 more than the first option. This option includes more fees than the first; however, it also narrows the remaining gap in renovation costs from about $60,000 to just around $20,000. Combined with the faster amortization offered in this loan, option 2 is the wiser investment strategy for Alexander.
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