Hi Radu Nedelcu. Fantastic question. The total value of the house is made up between debt (mortgage) and equity (which equals the value of the home minus the mortgage)

I think the best way to explain it is with an example.

If buy a $500,000 house with 20% down ($100,000).

You have a $400,000 mortgage and

$100,000 in equity (your down payment).

The 3% annual mortgage cost would be equal to $12,000 ($400,000 X 3%)

The 3% opportunity cost would be equal to $3,000 ($100,000 X 3%)

Combined the cost of debt and oppurtunity cost of equity= $15,000 ($12,000 for debt + $3,000 for equity). $15,000 is 3% of the total $500,000 value of the house.

Since the value of the house Must be equal to total debt + total equity and since both debt and equity are assumed to have a 3% cost, that is where we come up with the 3%.

Does that make more sense?



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