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FINANCING ON A
PROPERTY
Loan
Comparison Calculator
This calculator will help you to
compare the total interest charges of four different loans.
Instructions:
To calculate the
monthly payment amount and the
total interest of
any fixed term loan, simply fill in the
3 left-hand cells
of the first row
and then click on "compute." Use the other three rows to see what effects
are produced by changing any one of the loan's original variables.
# of
Payments |
Interest
Rate |
Principal |
Monthly
payment |
Total
Interest |
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Web Winder Site Traffic Magnets. All rights reserved.
Leverage
 Leverage
is the use of borrowed money. The concept of positive
and negative leverage helps clarify
decisions about financing.
Positive leverage
occurs when borrowing increases the return on the
investors equity. When cash-on-cash return (also called
the equity dividend rate) is greater with financing than
without, positive leverage exists. That is, the rate of
return on the investor's equity is greater if the
investor borrows part of the property cost than if the
investor pays all cash for it. This usually occurs when
the property is earning a return at a greater rate than
the cost of borrowing money.
Negative leverage
occurs when cash-on-cash return is less with financing
than without. Such a situation occurs when the cost of
borrowing money is greater than the rate at which the
property is earning a return.
Loan Constant
A Loan Constant
is the percentage of the loan balance that is needed to
pay principal and interest annually.
Loan Constant
(K%) = Annual Debt Service ÷ Amount of Loan × 100
When computing loans, it
is not necessary to compute the cash-on-cash rate for
each loan. The loan constant (k) and the
free-and-clear rate of return can be
compared as follows:
|
Positive Leverage |
Loan Constant
(K%) |
< |
*Free-and Clear Rate
of Return |
|
Negative Leverage |
Loan Constant
(K%) |
> |
*Free-and Clear Rate
of Return |
|
Neutral
Leverage |
Loan Constant
(K%) |
= |
*Free-and Clear Rate
of Return |
Leverage Effects of Financing
on a Property.
Automatic Calculator
 click here
|
VARIABLES |
No
Financing
Free-and-Clear |
30-year,
9.25% loan |
25-year,
11% loan |
25-year,
9.5% loan |
|
Cost of
Property |
793,000 |
793,000 |
793,000 |
793,000 |
|
-
Loan Amount |
0 |
637,500 |
637,500 |
637,500 |
|
Equity
Investment |
793,000 |
155,500 |
155,500 |
155,500 |
| |
|
|
|
|
|
Net
Operating Income |
83,000 |
83,000 |
83,000 |
83,000 |
|
-
Debt Service |
0 |
- 62,935 |
- 74,975 |
-66,838 |
|
Cash
Flow |
83,000 |
20,065 |
8,021 |
16,162 |
| |
|
|
|
|
*Free-and-Clear Rate
*Cash-on-Cash
Rate |
10.47% |
12.90% |
5.16% |
10.39% |
|
Loan
Constant (k) |
n/a |
9.87% |
11.76% |
10.48% |
|
Leverage: |
N/A |
Positive
K%<FCRATE
9.87<10.47 |
Negative
K%>FCRATE
11.76>10.47 |
Neutral
K%=FCRATE
10.48≈10.47 |
|
Financing Decision: |
? |
Borrow
Money |
Pay Cash |
? |
The return
in dollars is greater when a property is owned free-and-clear*
(Cash Flow $83,000) than when it is financed ($20,065, $8,021, and
$16,162), but the initial investment ($793,000) on free-and-clear*
is much higher than when it is financed. The capital of
$793,000 which could be making money if invested
elsewhere is tied up as equity in the property owned free-and-clear*.
Therefore, most investor's main concern is the rate
of return they receive on their cash invested
(the cash-on-cash rate). In the example above the highest
cash-on-cash rate (12.90%) is when the
property is financed with $637,000, 30-year, 9.25% loan.
* The free-and-clear rate
of return is the name commonly used for the cash-on-cash
rate of a property which is owned outright (no
financing).
Cash-on-Cash Rate (COC%) = Cash Flow ÷ Equity Investment
Free-and-Clear Rate = Net Operating Income ÷ Cost of Property
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