Credit Millionaire Ratios -17

Credit millionaires have one more ratio. In fact, this ratio is needed,
because most millionaires wouldn’t be able to pass the other two.
This ratio is reserved for individuals with significant investments or
businesses. Even small businesses get the benefit of using the credit
millionaire ratio—the Debt Coverage ratio.
The Debt Coverage Ratio is your total income from all sources minus
operating expenses. The difference with the ratio for the credit
millionaires and the consumer ratios is the consumer ratios first look to
the borrower’s income for repayment then to the secondary sources.

The credit millionaire ratio considers the net operating from your assets
as the primary method of payment for the debt on those assets. This
ratio puts the borrower’s earned income secondary to the income from
the assets. With the debt coverage ratio, the value of the income from
those assets is generally not reduced, as is rental property income for
an individual borrower.

A Debt Coverage Ratio of 1.0 represents break even cash flow, when the
net operating income from an investment or business is equal to the
debt coverage. The higher the number over 1.0, the better the ratio is.
A debt coverage ratio of 2.0 suggests that the monthly income from the
property is twice the payment on the debt. Lower than 1.0 means that
the income from the property isn’t enough to support the monthly loan
payments.

There are many documents which can be used to show your capacity.
Some are:
Income, W2s or 1099s, check stubs Tax Returns
Court orders for garnishment or support Rent rolls or leases
Royalty agreements Work history
Promissory notes with proof of payments

You can increase your capacity by widening the gap between your
income and expenses. You do this by both increasing your income and
reducing your expenses. Reducing your expenses is not as easy, but
well worth the efforts. We have all heard the axiom, “a penny saved is a
penny earned.” But a penny saved is really MORE than a penny
earned.

Consider this: every dollar that you want to spend, you must first earn.
When you earn income, whether through your job, business, or
investments, you must pay income tax on those earnings before you can
spend them for a non-business expense. So in order to spend $1.00,
you need to earn much more than that.

To calculate how much money you need to earn to spend $1.00, you
add your marginal tax rate (we’ll use 28% for this example) with the
15% tax for social security, Medicare, etc, resulting in a total tax of
43%. Which means you get to spend only 57% of what you earn. To get
the amount you need to spend $1.00, divide it by 57%. You see that an
individual in the 28% tax bracket needs to earn $1.75 to have $1.00 to
spend.
Thus it’s always better to decrease your expenses
than increase your income by the same amount.

What you really want to do is both.

Generally easier than decreasing your expenses is
increasing your capacity by increasing the depth
and breadth of your income.