Question

when it comes to lending we often hear about the front end and back end ratio that lenders use for primary homes. However, the rule is not as clear in the investment space. With that said what do you think is the optimal debt level? 15%, 25%, or maybe 30%? Additionally, do you think that once equity builds up and the leverage reduces that we should re-finance to buy more so that we maintain our preferred debt level?

Answer 1

Answer

The front-end ratio, also known as the mortgage-to-income ratio, is a ratio that indicates what portion of an individual's income is allocated to mortgage payments. The front-end ratio is calculated by dividing an individual's anticipated monthly mortgage payment by his/her monthly gross income. The mortgage payment generally consists of principal, interest, taxes, and mortgage insurance (PITI). Lenders use the front-end ratio in conjunction with the back-end ratio to determine how much to lend.

optimal debt level

Lenders prefer a front-end ratio of 28% or less for most loans and 31% or less for Federal Housing Administration (FHA) loans. Higher ratios indicate an increased risk of default. However, higher ratios can be accepted when certain factors (e.g., substantial down payments, sizable savings, and favorable credit scores) are present. For example, if a borrower with a high front-end ratio pays half of the purchase price as a down payment or increases his savings substantially, he may still be offered a mortgage

INVESTING  INVESTING STRATEGY

How do equity financing and debt financing affect a company's financials?

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BY INVESTOPEDIA

Updated Aug 31, 2018

Equity and debt are the two sources of financing accessible in capital markets. The term capital structure refers to the overall composition of a company's funding. Alterations to capital structure can impact the cost of capital, the net income, the leverage ratios and the liabilities of publicly traded firms.

The weighted average cost of capital (WACC)measures the total cost of capital to a firm. Assuming that the cost of debt is not equal to the cost of equitycapital, the WACC is altered by a change in capital structure. The cost of equity is typically higher than the cost of debt, so increasing equity financingusually increases WACC.

I dont think that we should re finance to buy more so that we maintain our preferred debt level.

Equity financing – raising money by selling new shares of stock – has no impact on a firm's profitability, but it can dilute existing shareholders'holdings, because the company's net income is divided among a larger number of shares. When a company raises funds through equity financing, there is a positive item in the cash flows from financing activities section and an increase of common stock at par value on the balance sheet.

If a firm raises funds through debt financing, there is a positive item in the financing section of the cash flow statement as well as an increase in liabilities on the balance sheet. Debt financing includes principal, which must be repaid to lenders or bondholders, and interest. While debt does not dilute ownership, interest payments on debt reduce net income and cash flow. This reduction in net income also represents a tax benefit through the lower taxable income. Increasing debt causes leverage ratios such as debt-to-equity and debt-to-total capital to rise. Debt financing often comes with covenants, meaning that a firm must meet certain interest coverage and debt-level requirements. In the event of a company's liquidation, debt holders are senior to equity holders