Wouldn’t the yields you suggest need a compound interest scenario?
That is if interest is compounded monthly, what yield would I have to earn to make an initial deposit of 144K grow to 160K at the end of the last period. With monthly interest credited to the account, you would need only 10.86% annually to obtain an effective annual yield of 11%.
Since, in Jonathon’s problem, the lender’s 144K is invested without any monthly payments except the lump sum payoff, I believe the yield computation should be performed with a simple arithmetic formula instead.
This is driving me crazy I think its the cold Medication
I own some vacant commercial property. I would like to build a 5000sf Steel building. It will cost me 140K hard cash. I have an appraisal of 250K. I need funding from private funds.
Here is my Idea
Borrower 160K from a friend of mine at 10% interest only 5 year term.
Pay One years worth of Payments at closing in the amount of $16,000.00
This will leave me 144K in escrow to draw on to build the building.
I have title company and appraiser to administrator the draws according to draw schedule.
If I sell the building the with in the first year I pay back 160K.
It will take me 4 months to build the building I have site plan inplace. The last 4 that I have built I usually have them sold before I finish. I am trying to figure out the yield on this type of note. My fingers are not pushing the right buttons. Say if I pay him 160K in 6 months plus the 16K he received at closing what would the yield be?
I know its a simple question but my fingers are not working.
Since you are prepaying a full year’s interest at settlement without prorating for early payoff, you are effectively borrowing only $144K.
Further you are agreeing to repay $160K to satisfy the note. Now if the note is repaid at the end of only one year, you will be giving the lender $16K for the use of his $144K during the year ($160K - $144K). Assuming one lump sum payment, this amounts to an effective annual yield of 11.11% for your lender.
If you pay off the note after only six months, the loan period is only half as long – doubling the effective annual yield to 22.22%.
For a payoff at the end of any month during the first year, the yield formula looks like:
Yield = (16/144) x (12/N) x 100%, where N = number of months until repayment
Note that if you repay the note after only one month (N = 1), the effective annual yield is a little over 133%.