How to Calculate the Loan Constant (Cost of Capital)

How to Calculate the Loan Constant (Cost of Capital)

The cost of capital for a property is called the Loan Constant (Constant) or Mortgage Constant. All loans have a certain interest rate and, unless there is an interest-only portion to the loan, all loans will require a principal and interest payment. The principal is calculated based upon the amortization of the loan. Thus, if the loan has a 30-year amortization, which is equal to 360 months, the principal must be paid in 360 installments so the loan is paid in full on the last loan payment.

The quoted interest rate of a loan is strictly the amount of interest that loan accrues. The loan constant, on the other hand, is expressed as an interest rate that incorporates both the interest and principal repayment of a loan. The formula is:

Loan Constant = [Interest Rate / 12] / (1 - (1 / (1 + [interest rate / 12]) ^ n))

n = the number of months in the loan term

Example 1: Suppose an investor received a loan for $4,000,000 at a 5.50% interest rate with a 30-year amortization. We can calculate the required annual loan payments once the loan constant is known.

Constant = [.055 / 12] / (1 - (1 / (1 + (.055 / 12]) ^ 360))

Constant = .06813 x 100 = 6.813% (rounded)

Annual payments = $4,000,000 * .06813 = $272,520

While the property has an interest rate of 5.50% the investor's actual cost of capital for the loan is 6.813% once the principal payment has been factored. If the above loan scenario has a 1.25x debt service coverage ratio (DSCR) requirement then an investor knows that the property must have at least the following NOI to support the loan:

$272,520 x 1.25 = $340,650

Consider that the reverse also holds true. A borrower can factor his potential debt service loan with the loan constant as long as he knows the NOI.

Example 2: A borrower wants to refinance his loan. His NOI is $560,000 and he has heard that his local bank will give him an interest rate of 6.25% for 25 years with a minimum DSCR of 1.25. What is the maximum loan he can borrower subject to an appraisal?

Constant = [.0625 / 12] / (1 - (1 / (1 + (.0625 / 12]) ^ 300))

Constant = .07916 x 100 = 7.916% (rounded)

Since the borrower knows the Debt Service Coverage Ratio must be 125% more than annual debt payments he can calculate the annual payments as the following:

$560,000 = $448,000

1.25

With $448,000 of the property's net operating income available to service the debt payments, his maximum possible mortgage based on debt service would be:

$448,000 = $5,659,424

.07916

As illustrated, the loan constant is a tool that can help a borrower easily understand the potential debt service associated with a property based upon a certain net operating income. Any borrower should make sure they check the loan constant with their lender to ensure that it matches his assumptions. For example, FHA multifamily mortgages have a mortgage insurance premium that is also factored into the loan constant which raises a property's cost of capital. A few other items to remember are:

Shortcoming #1: The constant only works for fixed rate loans. For adjustable rate mortgages that have changing monthly interest rates lenders will typically underwrite the maximum possible interest rate for that loan. Find out from your lender what is appropriate when modeling debt assumptions.

Shortcoming #2: The constant changes based upon the amortization of the mortgage. While not necessarily a shortcoming, it is important to understand the terms of any loan quote you receive from a lender or if your loan assumptions are accurate for a particular property or market. The shorter the amortization period of a loan, the higher the property's cost of capital.

Shortcoming #3: The constant does not factor interest-only periods. In the current lending environments, most lenders use an amortizing constant. When modeling cash flow it is important to note an interest only periods but although it will increase the cash-on-cash returns, it will not change the loan amount.

Robert Prouty is Co-Founder of Apartment Analytics Software, LLC [http://apartmentanalyticssoftware.com] one of the real estate industry's leading apartment investment software firms dedicated to providing investors with powerful and easy-to-use analytical tools enabling them to crunch the numbers with ease and make smart real estate investments with total confidence. Learn more by visiting [http://apartmentanalyticssoftware.com]

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Amortization Table - Calculate Your Own the Quick and Easy Way

Amortization Table - Calculate Your Own the Quick and Easy Way

Within the world of finance is a world of borrowing because using other people's money is how regular people get started in big business.

Borrowing is also how people who don't happen to have $400,000 at their disposal purchase nice new homes in nice neighborhoods. Without mortgages, very few people would own homes and the middle class wouldn't exist, as there would be two classes of people, the homeowners and those who rented from them.

The most important part of borrowing is knowing how much money you are paying back to the lender and how much money you are wasting on interest. Central to this knowledge is the understanding of what an amortization table is and how to use it.

In this article not only will we discuss these two things, but also you will actually be taught how to build an amortization table and we will calculate one as we go along.

What will the table tell us?

The first step to calculating an amortization table is the understanding of what the table will tell us. In short, amortization tables break monthly payments into two parts, the principal paid and the interest paid. So, it would behoove us if we knew what the total monthly payment was to begin with.

I know, it probably sounds like a cop out because we could calculate the payment, but that part of the equation will be left for another article. Here, we're going to go to a financial or mortgage calculator and find out the payment. Then, we will do the calculations to break the payment down into its two parts.

Let's start by using an example. In this example, the numbers may sound peculiar but we are going to use numbers that will make the example easy to follow. So, let's say we have a mortgage with a principle of $360,000. The mortgage will be paid off over 30 years, or 360 monthly payments. The interest rate will be a 1970's type 12%.

Interest calculation formula

Now, we will see how much interest we will pay on the first payment. First we will take the amount of principal we have left to pay. In this case it will be the whole mortgage of $360,000. We need to divide it by the number of months we have left to pay because we are building a monthly amortization table. This will tell us the amount we are paying interest on for one month.

Next, we want to multiply this amount by one month's interest. One month's interest will be found by dividing the yearly interest rate by 12. Then we have to multiply this amount by the number of months left to pay on the mortgage, in this case 360. If we didn't do this, we would just be seeing the amount of interest that would be paid if there were only one month left to pay the mortgage.

Simplify the formula

Here's how that formula looks: Int. on month's payment=principal left/ number of months left x monthly interest x number of months left. Now, if you look at the formula you will see the term "number of months left" twice. Once it is a numerator (above the line) and once it is a denominator (below the line). This means we can divide it by itself. So, the formula now looks like: Int. on month's payment=principal left x monthly interest. Pretty easy, huh!

Begin calculating

Now, let's build our amortization table. $360,000 x .01= $3,600. This is the interest paid the first month. Not sure where the .01 came from? It is 12%, or .12, which is the yearly interest rate divided by 12 giving us the monthly interest rate.

Next, we take the monthly payment we got from a mortgage calculator, which is $3,703.01, and we know the interest on the first payment is $3,600 so we will subtract it from $3,703.01, which will tell us the principal part of the first payment is $103.01. This is the first entry in our amortization table. $3,6000 interest and $103.01 principal.

At this point, we know we no longer owe $360,000 on the mortgage because we have paid $103.01, so the principal left is now $360,000 - $103.01, or $359,896.99. We now multiply this number by .01 to get the interest part of the second payment. This is $3,598.97 and, since we know the total payment is $3,703.01, we will subtract $3,598.97 from it to get $104.04 which is the principal paid on the second payment.

There you have it. You just continue calculating in this way for another 358 payments and you will have built your amortization table completely by hand. This, by the way, is something few people can say!

Even if you don't continue on making these calculations, you now know, from a very inside perspective, exactly what amortization is all about!

Ed Lathrop is a successful Real Estate investor. He has developed a Website where you can print out a mortgage payment table showing monthly payments for hundreds of different combinations of interest rates and borrowed amounts. Get your free printout at : House Payment Chart Also, find out how to get your amortization schedule and use it to save big money at: Amortization Schedules Free These sites are not owned by any lender, so no one will harass you for visiting!

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Qualify for a Mortgage After Bankruptcy

You can qualify for a mortgage after bankruptcy or a similar financial calamity. Many people assume a bankruptcy appearing on a credit report for 10 years means they are disqualified from a home loan for 10 years. Wrong!

However, just because it is possible to qualify for a mortgage after bankruptcy does not mean doing so will be easy or require no work. Here are the key facts you need to know about qualifying for a mortgage after bankruptcy, and the three steps you can take to recover from bankruptcy.

4 Key Facts You Need to Know

Well-meaning but uninformed advice givers try to steer people away from bankruptcy by saying a bankruptcy makes qualifying for a loan impossible for 10 years, and will haunt them for the rest of their lives. Both statements are urban myths. If you hope to qualify for a home loan, here are the facts you need to know.

Fact No. 1: People qualify for a home loan 2 years after a chapter 7 or 13 discharge. There is no "lender punishment" for people who file for bankruptcy. According to FHA, VA, Fannie Mae, and Freddie Mac documents, the two-year waiting period is in place so they can see if the applicant pays their new debt obligations on time. In some cases, an otherwise qualified person need wait 12 months after their bankruptcy to obtain a loan.

Fact No. 2: Bankruptcy causes a severe decrease in a person's credit score. Expect your FICO score, the credit scoring tool used by most home loan lenders, to fall into the mid-500 range. As a result, plan to spend time rebuilding your credit so it meets the minimum credit score qualifications set by lenders.

Fact No. 3: Bankruptcy, especially a chapter 7 that wipes out personal debt, causes your debt-to-income (DTI) ratio to improve. Lenders see DTI as a key indicator of a borrower's ability to handle debt.

Fact No. 4: Obtaining new credit cards is not an issue after bankruptcy. Some lenders see the recently bankrupt as desirable loan candidates because people cannot qualify for chapter 7 for 8 years after a discharge, and 6 years after a chapter 13 (some exceptions apply). Most recently bankrupt people receive a flood of offers from banks who see this group as a lucrative market for high-interest and high-fee credit card offers.

Let's look at the three steps you need to recover from a bankruptcy:

1. Rebuild your credit
2. Put your financial house in order
3. Understand the qualifications for FHA and other home loans

Step 1: Rebuild your Credit

Regardless of your starting FICO credit score, you should expect your post-bankruptcy FICO score to fall to 530 to 560. The time to full recovery will vary and depends on the effort you put into boosting your credit score and how high you want your score to be.

Start Rebuilding Your Credit History With A Secured Credit Card

A secured card is a tool to help you improve your credit score. Secured credit cards are simple: You deposit $200 to $5,000 with the credit card issuer. That amount becomes your line of credit. You use a secured credit card like you would any other credit card. Your payment history, on-time or delinquent, is reported to the credit reporting agencies — Equifax, Experian, and TransUnion — like any other credit card.

Beware predatory credit card issuers. Shop around to your local banks and credit unions to find the best deals in a secured credit card. Don't fall for the first offer arriving in your mailbox.

Diversify Your Credit With An Auto or Installment Loan

Each type of credit account or loan is called a trade line in the credit reporting business. Credit scores reward people with trade line diversity. Do not open multiple secured credit cards hoping to boost your score quickly. Instead, open one secured credit card, and then move on to a department store or oil company card, which will be viewed as separate trade lines.

Then consider buying a used car with a loan from your local bank or credit union. Avoid a buy-here-pay-here dealership because they often do not report any information to the credit reporting agencies. Alternatively, buy a single piece of furniture on an installment loan that is reported to the credit reporting agencies, and pay off the loan after six to nine months.

Make Your Payments On Time Every Time

The single largest factor that makes up a credit score is your payment behavior. The rule here is simple — make your payments on time every month. Consistent positive behavior is rewarded, and missed payments will punish your credit score.

Check Your Credit and Dispute Incorrect Information

Review the information appearing in your three credit reports to see if any incorrect information appears. Dispute any errors by following the steps on the page just mentioned. Common errors include accounts still indicating a balance due after the bankruptcy, and someone else's accounts misapplied to you. If you see many mystery accounts in your report, this may be a sign of identity theft.

Step 2: Put Your Financial House in Order

The intent of bankruptcy is to give a person a fresh start. This means if you had a recent successful bankruptcy discharge and are interested in qualifying for a mortgage, you should have no or a manageable amount of debt. If you keep your debt low, you will have a very attractive DTI when you apply for your mortgage.

The best way to keep your debt low is to create and stick to a budget.

Another key element in qualifying for a home loan is having a down payment. Pay yourself every month by depositing funds into a savings account. Save more than you need for a down payment so that you can show your lender you have cash reserves on hand.

Step 3: Understand the Qualifications

If you focus on improving your credit score to lift it from the mid-500s to the high 600s, keep your DTI low, and save for a down payment, you should qualify for a home loan. But, you will have to wait for 2 years from the date of your discharge to do so. Let us look at the qualifications for FHA- and VA-guaranteed loans. We also look at the standards Fannie Mae and Freddie Mac have in place today before each will consider investing in a recently bankrupt person's loan.

FHA’s Bankruptcy Rules

Generally, a person who has a chapter 7 bankruptcy discharge must wait for 24 months after the date of discharge before they can apply for a new FHA loan. During this span of time, the FHA requires the applicant to re-establish good credit, or chose not to incur new credit obligations. However, a person need not wait for 2 years.

After 12 months following a chapter 7 discharge, the FHA may approve an application if the borrower can show three facts:

1. The bankruptcy was caused by extenuating circumstances beyond his or her control, such as:
   • The death of the principal wage earner, or
   • A serious long-term uninsured illness
2. An ability to manage his or her personal finances in a responsibly manner.
3. The events leading to the bankruptcy are not likely to recur.

A person who has a successful chapter 13 bankruptcy order must wait for 24 months after the date of discharge before they can apply. However, the FHA may approve an application after 12 months if the borrower can prove three things:

1. One year of the pay-out period under the bankruptcy has elapsed,
2. All required payments have been made on time, and
3. The borrower received written permission from bankruptcy court to enter into the mortgage transaction.

If the Chapter 13 bankruptcy order occurred in the 12-to-24-month time span, expect the approval process to take longer than if the bankruptcy occurred more than two years ago.

VA’s Bankruptcy Rules

Like the, FHA, the Veterans Administration accepts applications from people who had a chapter 7 or 13 bankruptcy discharged more than 2 years ago. The VA will consider an application with a bankruptcy discharged 12 to 24 months ago under the following conditions:

1. The borrower reestablished a satisfactory credit profile, and
2. The bankruptcy was caused by circumstances beyond the applicant's control, such as unemployment, medical bills, and so on.

If the bankruptcy was discharged within the past 12 months, the VA believes it cannot determine if the borrower is a satisfactory credit risk.

If the borrower applies with a spouse jointly, the VA will look at the spouse's credit report for, among other factors, a recently discharged bankruptcy. The VA applies the same bankruptcy rules to spouses who apply for VA loans jointly.

Conformant and Non-Conformant Bankruptcy Rules

Mortgages today usually involve four parties:

• Borrower
• Originator. The originator could be a national bank or a local broker. The originator qualifies and funds the loan, and then sells it.
• Investor. Today, the investors in most home loans are Fannie Mae and Freddie Mac.
• Servicer. Collects monthly payments and manages escrow accounts for the investor. May be a national bank.

Conforming loans are sold to Fannie and Freddie. Non-conforming loans are sold to private-label mortgage securities investors.

Fannie Mae's Bankruptcy Rules

Fannie Mae requires a four-year waiting period after a chapter 7, measured from the discharge or dismissal date of the bankruptcy action. It will permit a two-year waiting period if extenuating circumstances can be documented.

Fannie Mae distinguishes between Chapter 13 bankruptcies that were dismissed and discharged. Fannie measures the waiting period required for chapter 13 bankruptcy actions as follows:

• Two years from the discharge date, or
• Four years from the dismissal date.

According to Fannie Mae, the shorter waiting period based on the discharge date recognizes that borrowers have already met a portion of the waiting period within the time needed for the successful completion of a chapter 13 plan and subsequent discharge. A borrower unable to complete the chapter 13 plan and received a dismissal will be held to a four-year waiting period.

Both Fannie and Freddie consider extenuating circumstance to be a nonrecurring or isolated circumstance, or set of circumstances that:

• Was beyond the Borrower's control,
• Significantly reduced income and/or increased expenses, and
• Rendered the Borrower unable to repay obligations as agreed, resulting in significant adverse or derogatory credit information.

Freddie Mac's Bankruptcy Rules

Freddie Mac's bankruptcy rules are very similar to Fannie Mae's, although Freddie documents its rules differently.

Private Label Mortgage Investors

Some members of Congress would like to see Fannie and Freddie back out of the market in favor of private-label securities investors, so non-conforming loans may become more important in the future.

Today, there are no uniform standards private-label mortgage investors follow for handling borrowers with recent bankruptcies. Some avoid them as too risky. Others embrace the perceived added risk. If you have a bankruptcy that is seasoned less than 12 months, your best chances for finding a home loan is to consult with a broker who has access to many funding sources. You should expect to pay more in fees or interest.

Quick Tip: Dealing with debt? A Bills.com debt resolution partner might be able to help.

Summary

Filing bankruptcy does not make it impossible for you to qualify for a mortgage. You can qualify for an FHA loan as soon as one year after a chapter 7 discharge, or with the bankruptcy court's permission if you have a chapter 13. Your first key strategy you should work on is boosting your credit score by making all of your payments on time. If your accounts were closed after discharge, then consider opening a secured credit card and bootstrapping yourself into more credit accounts that you pay on time.

Your second key strategy should be to develop a savings plan so that you have a down payment and cash reserve you can show the lender in your financial disclosures.

If your bankruptcy was less than 4 years ago, focus on finding an FHA loan, unless you can document extenuating circumstances. In that case, then your options open up to FHA, and loans conforming to Fannie and Freddie's requirements.

Use Your Money Wisely When Making a Down-Payment

Use Your Money Wisely When Making a Down-Payment

When you are buying a home, the size of your down-payment is a very important factor. Of course, it is not the only important factor. Your credit rating, credit history, and debt-to-income ratio are also crucial.

What is Down Payment?

A down-payment is the total amount of cash you put down towards your home purchase. Before the mortgage meltdown, a few years ago, there were financing options that allowed even borrowers with less than excellent credit to finance a home purchase with 0% down, sometimes even without proof of their income. Now, the days of 0% down for a conventional loan are gone.

Amount of Cash You Need

Your down-payment is not the only expenses you need to account for, when you want to buy a home. You also need to have cash available to cover:

The loan fees that your lender charges (origination fees and discount points)
The third party fees you'll pay (appraisals, title fees, escrow charges, etc.)
Pre-paid costs for property taxes and homeowner's insurance

Any minimum reserve requirements your lender requires
Don't assume that all the money that you've saved up is money you can use for a down-payment. For example, if you want to buy a home and have saved up $20,000 to buy one, you have to account for the costs listed above, so you figure out the right way to use your cash to get the best loan type, interest rate, and financing terms.

How much money you have to put towards your down-payment will affect:

The type of the loan you get
The total amount you can borrow
Whether you have to pay for mortgage insurance
Down-payment, LTV & Loan Programs

Your eligibility for different loan programs is dependent on how your down-payment affects your loan-to-value (LTV). Your down-payment is the amount of money you put into purchasing the property. For most borrowers, the down-payment represents the difference between the purchase price and the loan. However, your down-payment is not the only factor used in determining your LTV.

Your LTV is based on:

Total Loan Size: Your total loan amount needed to purchase the property and pay for any closing costs that you roll into the loan
Home Value: The lower amount between the purchase price and the appraised value is used to determine your LTV.
Down-payment and LTV requirements differ from loan program and can also vary from lender to lender. Here are some of the main points to consider

VA Loans: VA loans have the lowest down-payment requirements. If you are eligible for a VA loan, you can buy a home with 0% down.
FHA Loans: FHA loans offer the next lowest down-payment options. You can get an FHA loan with a down-payment as low as 3.5% and can roll-in closing costs without it affecting your LTV. FHA loans also are attractive as they have less strict credit requirements than conventional loans

Conventional Loans: Most conventional loans require at least a 10% down-payment. For a conventional loan, if you roll your closing costs into the loan, it will raise your LTV. One reason to take out a conventional loan is to avoid the need for paying for mortgage insurance, but that requires you to make a down-payment of at least 20%, including the closing costs, if you include them in your loan.

Mortgage Insurance & Down-Payment

If you don't have 20% to put down on the your purchase mortgage loan, you're going to have to pay for mortgage insurance. While it is a good goal to aim for buying a home with 20% down, it is not always realistic. The only way that you may qualify for a home loan is in a loan program that requires mortgage insurance.

Mortgage insurance can add a significant cost to your loan's monthly payment. Not only that, your costs for mortgage insurance are included in your debt-to-income ratio. Therefore, if you have to pay for mortgage insurance, it will affect how expensive a home you can buy.

If your purchase mortgage requires mortgage insurance, make sure you know how much you have to pay and for how long. For instance, there is a big difference between the mortgage insurance requirements of an FHA loan and a conventional loan. FHA loans require both an up-front mortgage insurance payment (UFMIP) and an annual mortgage insurance (which you pay monthly). There is no up-front mortgage insurance for a conventional loan. The current FHA UFMIP is 1.75% of your loan total. If you have a $200,000, your UFMIP would be $3,500. UFMIP can be rolled into your loan.

Cash Reserves & Down-Payment

Your lender may require you to have a certain amount of cash in reserve, in order for you to qualify for the loan.  A cash reserve requirement protects the lender, reducing its risk. Your cash reserves would be used, if necessary, in case of some kind of emergency.

Cash reserve requirements depend on your credit score, LTV, and DTI. In some cases, you may need enough reserves to cover your mortgage payment for six months. Some low-risk borrowers are not required to have a cash reserve at all.

Using Your Cash to Your Advantage

Buying a home and making a down-payment requires a lot of planning. You need to allocate your cash effectively. If you have a fund to use to buy your house, don't assume that you can use it all for a down-payment.

Start by speaking with a loan officer, to find out what kind of loan that you qualify for. See what kind of down-payment that loan requires, determine if you will need to pay for mortgage insurance, and whether or not you'll be required to have cash reserves on hand.