Financial issues

We now assume you want to finance the building purchase of $76,363.64 with a mortgage of $25,000. In effect, the single project “building” is being turned into two different projects, each of which can be owned by a different party. The first project is the project “Mortgage Lending.” The second project is the project “Residual Building Ownership,” i.e., ownership of the building but bundled with the obligation to repay the mortgage. This “Residual Building Ownership” investor will not receive a dime until after the debt has been satisfied. Such residual ownership is called the levered equity, or just the equity, or even the stock in the building, in order to avoid calling it “what’s-left-over-after-the-loans-have-been-paid-off.”
What sort of interest rate would the creditor demand? To answer this question, we need to know what will happen if the building were to be condemned, because the mortgage value ($25,000 today) will be larger than the value of the building if the tornado strikes ($20,000 next year). We are assuming that the owner could walk away from it and the creditor could repossess the building, but not any of the borrower’s other assets. Such a mortgage loan is called a no-recourse loan. There is no recourse other than taking possession of the asset itself. This arrangement is called limited liability. The building owner cannot lose more than the money that he originally puts in. Limited liability is a mainstay of many financial securities: for example, if you purchase stock in a company in the stock market, you cannot be held liable for more than your investment, regardless of how badly the company performs.