In real estate investing there is a fundamental relationship between the money that you borrow to purchase the investment and the equity capital you invest. The money that is borrowed to purchase the investment property, whether it’s a home or an apartment or any other commercial property is called debt. It’s an obligation that requires one party, the debtor, to pay money to another party, the creditor. Usually the debt is paid back through a series of payments. The repayment process is called amortization.
When you purchase a real estate investment, the lender or creditor will usually let you borrow between 60% and 80% of the purchase price or value of the asset. Usually a lender will let you borrow a higher percentage if the property is residential than if it’s a commercial property. The ratio between the amount borrowed and the amount of equity capital invested is known as the loan-to-value (LTV) ratio.
When investing in real estate, the higher the LTV, the lower the cash flow. The lower the cash flow, the lower the cash-on-cash return to the investor. So, as a real estate investor, try to balance the percentages between debt and equity so that you have a comfortable cash flow without creating undue risk by putting too much debt on the property.
