The Debt Constant: How Much Mortgage Can the Rent Pay?

Before the price, the location or the finishes, there is a more useful question to ask about any rental property: once you own it, will it take money from you every month, or will it pay its own way? The answer comes from a number most buyers never calculate, the debt constant.

What the debt constant is

The debt constant is the share of the loan you pay each year, interest and principal together. A $100,000 mortgage at 6.75% over 30 years costs about $7,783 a year, so its constant is 7.78%. A shorter term raises it, because you repay principal faster. On an interest-only loan, the constant equals the rate.

The comparison that matters

Your property has a yield of its own: the net operating income, meaning the rent after vacancy and every cost of owning, divided by the price. That is the cap rate. Put the two side by side.

• Cap rate above the constant. Every dollar you borrow earns more than it costs, so debt adds to your return.
• Cap rate below the constant. Every dollar you borrow costs more than it earns. Past a certain loan size, the difference comes out of your pocket each month.

The zero-cost mortgage

There is one loan size at which the net rent exactly covers the mortgage payment. We call it the zero-cost mortgage, and the formula is simple: divide the net operating income by the debt constant. If you want a cushion, divide by the constant times a safety margin, which lenders call the debt service coverage ratio (DSCR). Most DSCR lenders ask for 1.20 to 1.25.

A worked example

Take a $500,000 Miami condo renting for $3,800 a month. After 5% vacancy, property tax of about 1.9% of the price, $750 a month in HOA dues, $2,400 a year of insurance, 8% management and a 3% maintenance reserve, the net operating income is about $17,650 a year. That is a cap rate of 3.5%.

At 6.75% over 30 years the constant is 7.78%, so the largest loan the rent can carry is $17,650 divided by 7.78%, or about $227,000. That is 45% of the price. Borrow the 75% a bank would offer and the owner pays roughly $1,000 a month to hold the unit.

The same numbers point to the other lever. To borrow 75% at zero cost with this rent, the price would need to be about $351,000. Your cost is where you win.

Where the return comes from at zero

A zero-cost structure can still build wealth. Every payment reduces the principal, so the tenant is paying down the loan for you, and the property appreciates on its full value while your money is only the down payment. Neither of those shows up in the monthly cash flow.

What can move the numbers

• Vacancy and repairs arrive unevenly, so keep reserves outside the deal.
• In Florida, insurance and reassessed property taxes can rise quickly after a purchase.
• Adjustable and short fixed-period loans reset, and the constant changes with them.

Run your own numbers

We built a free calculator in English, Spanish and Portuguese. Enter the price, the rent and every cost of owning, and it shows the largest mortgage the rent can pay, the cash you bring and how the picture changes over ten years. Open the zero-cost mortgage calculator.

Frequently asked questions

What is a good debt constant?

There is no fixed number. What matters is how it compares with the cap rate of the property you are buying. A constant below the cap rate means borrowing helps, and a constant above it means borrowing costs you.

Does an interest-only loan lower the constant?

Yes. With no principal in the payment, the constant equals the interest rate, so the rent can carry a larger loan. You build no equity through the payment, and the full balance is still owed at the end.

What DSCR do lenders require?

Most DSCR lenders look for net income of 1.20 to 1.25 times the annual mortgage payment, which keeps a cushion between the rent and the debt.

Infinity⁹ (Infinity Capital Asset Management, LLC) is an Exempt Reporting Adviser with the SEC, CRD# 330526. This article is educational and does not constitute legal, tax or investment advice, or an offer to sell or a solicitation of an offer to buy any security. Examples are hypothetical and simplified, and figures are illustrative, not projections. Any offering is made only through definitive documents and only to accredited investors.