Post by Brian Gibbons on Mar 19, 2005 17:51:37 GMT -5
Loan Constants
One of the most important tools for evaluating any investment with debt, is the mathematical relationship between the debt service and the outstanding balance. This relationship is known as a Loan Constant.
Loan Constants will not solve problems, but they will tell you what is going inside an amortizing loan. To determine a loan constant, divide the ANNUAL DEBT SERVICE (this amount remains the same throughout the life of the loan) by the OUTSTANDING BALANCE OF THE LOAN (this amount gets smaller as the loan amortizes) The answer is expressed as a percentage.
Here is the formula:
LC = Annual Debt Service
Outstanding Balance
For Example:
A car loan: $10,000 at 10% For 48 months
with monthly payments = $253.63 x 12 = $3,043.51
per year annual debt service
Months Paid Balance at End of Period Loan Constant
0 $10,000.00 30%
12 $ 7,860.18 39%
24 $ 5,946.29 55%
36 $ 2,884.87 105%
Notice, as the outstanding balance decreases and the debt service remains constant, the ratio gets larger and larger. It takes more dollars per dollar of debt to service that debt. This fact is very important to know in analyzing Paper, real estate opportunities and solving financial problem.
What is a Loan Constant?
As the loan constant gets bigger the faster the loan is being amortized. But large loan constants eat up the cash flows. So, if you want to free and clear a property quickly, go for a bigger and bigger loan constant. If you are in need of cash flows, soften (make smaller) the loan constant. Calculate the loan constant on mortgages on your home, car loan, student loan, credit card loan or consumer loan. Here is a great opportunity - to start a Paper portfolio (cash generator) by paying off these high constant loans with available cash or low constant loans. By paying off the high constant debt with softer constant debt, you have increased your monthly cash flows by the difference between the old high debt service and the new lower debt service.
The idea is to pay off the high loan constant debts and not repeat the process by getting into more high constant loans. However, it is very important to note that you have greatly extended the time period over which you must repay the debt.
When you are studying a note offered for sale, be sure to determine the present loan constant. The bigger it is the better the yields. And should the payor of the note get in trouble in the future, a big loan constant can be softened to improve his situation. Now that you are aware of the important relationship between debt and debt service, I hope you will always analyze each and every debt every time you come across a loan.
One of the most important tools for evaluating any investment with debt, is the mathematical relationship between the debt service and the outstanding balance. This relationship is known as a Loan Constant.
Loan Constants will not solve problems, but they will tell you what is going inside an amortizing loan. To determine a loan constant, divide the ANNUAL DEBT SERVICE (this amount remains the same throughout the life of the loan) by the OUTSTANDING BALANCE OF THE LOAN (this amount gets smaller as the loan amortizes) The answer is expressed as a percentage.
Here is the formula:
LC = Annual Debt Service
Outstanding Balance
For Example:
A car loan: $10,000 at 10% For 48 months
with monthly payments = $253.63 x 12 = $3,043.51
per year annual debt service
Months Paid Balance at End of Period Loan Constant
0 $10,000.00 30%
12 $ 7,860.18 39%
24 $ 5,946.29 55%
36 $ 2,884.87 105%
Notice, as the outstanding balance decreases and the debt service remains constant, the ratio gets larger and larger. It takes more dollars per dollar of debt to service that debt. This fact is very important to know in analyzing Paper, real estate opportunities and solving financial problem.
What is a Loan Constant?
As the loan constant gets bigger the faster the loan is being amortized. But large loan constants eat up the cash flows. So, if you want to free and clear a property quickly, go for a bigger and bigger loan constant. If you are in need of cash flows, soften (make smaller) the loan constant. Calculate the loan constant on mortgages on your home, car loan, student loan, credit card loan or consumer loan. Here is a great opportunity - to start a Paper portfolio (cash generator) by paying off these high constant loans with available cash or low constant loans. By paying off the high constant debt with softer constant debt, you have increased your monthly cash flows by the difference between the old high debt service and the new lower debt service.
The idea is to pay off the high loan constant debts and not repeat the process by getting into more high constant loans. However, it is very important to note that you have greatly extended the time period over which you must repay the debt.
When you are studying a note offered for sale, be sure to determine the present loan constant. The bigger it is the better the yields. And should the payor of the note get in trouble in the future, a big loan constant can be softened to improve his situation. Now that you are aware of the important relationship between debt and debt service, I hope you will always analyze each and every debt every time you come across a loan.