The terms mentioned on this page are for informational purposes only. Every situation is unique. Consult with a professional real estate agent, mortgage professional, accountant or attorney for questions pertaining to your situation.
The cash-on-cash analysis is used by investors to calculate the return on a rental property. It compares your annual pre-tax cash flow against your total upfront initial investment. Your initial investment includes down payment, closing costs and any initial repair costs. The income generated by the property includes rental and other income minus expenses. Expenses include operating expenses such as taxes, insurance and maintenance as well as vacanies expenses. Expenses also include your monthly principal and interest costs, otherwise known as debt service.
Debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income. Lenders use this number to measure your ability to make your mortgage payment.
An IRS tax allowance for owners of investment property. Because structures deteriorate or become obsolete over time, the IRS concludes that any physical structure has a physical life of only so many years. The IRS further concludes that the owner realizes a financial loss through ownership of the property and should therefore be granted an annual depreciation allowance when filing income taxes.
The amount in which an asset's selling price exceeds its original purchase price. Generally, when property is sold at a profit, the IRS is owed money in the form of capital gains tax.
Used in Depreciation Allowance. Depreciable basis is the original value of an investment property minus the value of the land.
Used in Depreciation Allowance. As determined by IRS tax code: 27.5 years for residential property, 39 years for non-residential property.
Closing costs apply to buyers and sellers alike. For the buyer, this usually consists of costs associated with a mortgage loan as well as government transfer fees. For the seller, this usually consists of costs associated with the real estate sales commission as well as government transfer fees. In Florida, government transfer fees generally include documentary stamps and deed stamps. Other closing costs may apply as well.
When shopping for a mortgage, you'll find lenders posting interest rates along with Points and APR (see APR). Mortgage points, also known as discount points, are fees you pay directly to the lender at closing in exchange for a reduced interest rate. Sometimes referred to as “buying down the rate,” this can work to lower your monthly mortgage payments. One point equals 1 percent of your mortgage amount, ie. $1,000 for every $100,000. Essentially, you are paying interest up front in exchange for a lower interest rate over the life of your loan.
In general, the longer you own the home, the more points help you save on interest over the life of the loan. Have your lender run the numbers to see what is right for you.
APR stands for annual percentage rate. When shopping for a mortgage, you'll find lenders with an advertised interest rate along with the APR. The interest rate refers to the annual cost of a loan to a borrower and is expressed as a percentage. Similary, the APR is expressed as a percentage but is the annual cost of the loan including fees. These charges or fees include things such as mortgage insurance, most closing costs, discount points and loan origination fees. The APR gives you a more accurate depiction of what you're really paying to borrow the money. Keep in mind, because the various fees mentioned are paid up front, your monthly payment is based upon the interest rate on the promissary note, not the APR.
Lenders look at information regarding your income, assets, liabilities, credit and other things. The loan origination fee is the cost charged by your lender to pay for the research they have done on you as a borrower. This cost is often between .5% and 1% of the total home loan but can vary depending on the complexity of your loan.
The amount you borrow as it relates to the value of the property you intend to purchase. The (LTV) ratio is a measure of risk that lenders examine before approving a mortgage. Assessments with higher LTV ratios are generally considered higher risk and, therefore, carry higher loan costs. LTV ratio = Mortgage Amount ÷ appraised property value. If you are using a mortgage of $160,000 to purchase a $200,000 home, your LTV would be 80% (160,000 ÷ 200,000 = .80). A loan with a high LTV ratio may require the borrower to purchase mortgage insurance.
The one percent rule is a quick analysis used by investors that says a rental property should rent for 1% of the property's price + upfront repairs. It's a very general rule of thumb that does not account for different markets, property appreciation and other factors. Using the 1% rule, if an investor is interested in a duplex costing $275,000 that needs $25,000 in repairs, they would look for a monthly rent income of $3,000.
A "rule of thumb" used by lenders stating that a mortgage applicant’s debt-to-income ratio should be no more than 28% on the front end and no more than 36% on the back end.
Front end Ratio refers to the percentage of your gross monthly income (before tax) used to make your house payment (PITI). ex) Housing Payment ($2,000) ÷ Monthly Income ($8,000) = 0.25 (25%)
Back end Ratio refers to the percentage of your gross monthly income (before tax) against your total monthly recurring debt. This includes your house payment along with payments like credit card payments, car payments, student loan payments, child support, etc. ex) Total recurring debt ($2,880) ÷ Monthly Income ($8,000) = 0.36 (36%)
Private Mortgage Insurance (PMI) is insurance paid by a borrower when purchasing with a low down payment. It protects the lender against loss if you (the borrower) default on the loan. It gives qualified borrowers the ability to purchase with as little as three to five percent of the purchase price instead of the conventional 20 percent.
Mortgage Insurance Premium (MIP) is insurance associated with FHA loans. Like PMI, it is paid by the borrower to protect against loan default. MIP terms differ from PMI terms and should be discussed with your mortgage broker.
Cash flow is the money that flows in and out of your business in a month. Positive cash flow results when there is more money coming in than there is money going out. Conversely, negative cash flow results when there is more money going out than there is money coming in.
In real estate, leveraging is using borrowed capital to purchase more real estate than you could if using just the cash on hand. Using a simple analysis, let's say you have $500,000 cash to invest. You could buy one property for cash at $400,000 and possibly rent this property out for $4,000 per month. This would give you a 12% return annually (before taxes and expenses). Additionally, you have the potential for growth if the property values increase. Conversely, you could leverage your money by financing three properties totaling $1,200,000. You finance the deal using a total of 25% down ($300k) at a rate of 5% for 30 years. You've now invested less money but control 3 times the amount in assets. Using the cash on cash analysis and assuming a monthly income of $12,000, you'd have a 28.67% return annually (before taxes and expenses). Additionally, you would now have even more growth potential if property values increase. All of this can be done provided interest rates are favorable.