Real Estate Math
One of the main reasons that I launched this site is to provide a resource for aspiring agents to learn more and/or get a quick refresher on essential math skills that will be needed to pass a real estate exam and then be used in every practice of being an agent.
Currently, I have the written posts on the following subjects. Please click on the links below to see more about each topic. As always, I appreciate your input and welcome any comments to improve this sight.
Financial Math in Real Estate:
Starting with the Basics (Fundamental Math Concepts)
Building on a Solid Base
A home that stands firmly up to the elements and time is most likely built on a solid foundation. The purpose of this post is to help establish a solid foundation of the basic math skills needed to kick start your understanding of real estate math.
Basic rule for rounding is this – the digit you want to round is less than 5 then round down. Conversely, if the digit is 5 or greater then round up.
Round the following number to 2 decimal places:
1.33345 = 1.33 (because the 3rd digit is a 3 you should keep the second digit the same).
Round the following number to 2 decimal places:
1.33645 = 1.34 (because the 3rd digit is a 6 you should round up the second digit, 3 becomes a 4).
Since most of you will use calculators for solving your math problems you will have some rounding that will need to take place. For this post and all of the examples we will assume the decimals will be rounded to the 4th decimal.
Let’s say that you have to calculate 600 divided by 7 = 85.71428571…
Rounded to the 4th decimal place will be 85.7143
The 5th digit after the decimal is an 8 so you round up the 3rd digit from a 2 to a 3.
Now you round the examples below to the 4th decimal:
- 8 ÷ 3
- 7 ÷ 3
- 12 ÷ 11
Answers: a) 2.6667, b) 2.3333, c) 1.0909
A fractions top number is the numerator and the bottom number is the denominator. To convert fractions to numbers simply take the numerator and divide it by the denominator.
Examples: 1/2 = 1 ÷ 2 = 0.5
2/3 = 2 ÷ 3 = 0.6667
3/4 = 3 ÷ 4 = 0.75
Real Life Example:
Mr. Buyer would like your help finding a lot that is at least a 3/4 of an acre. A fellow agent tells you that he may have the perfect lot for your client that is 5/8 of an acre.
Will the lot meet the requirement of your client?
Answer: Mr. Buyer wants a lot to bigger than 3/4 of an acre (3 ÷ 4 = 0.75 acres). The lot that your fellow agent mentioned to you is 5/8 of an acre (5 ÷ 8 = 0.625 acres).
So the answer is no. The lot is not big enough for your client.
Converting a percentage is as simple as moving the decimal place two digits to the left.
50.3% = 0.503
Let’s say you have a percentage without a decimal such as 6%. The procedure is still the same:
6% = 0.06
To convert a number to a percentage the process is just reversed.
0.654 = 65.4%
You have a buyer that has placed an offer on a $130,000 home and your commission rate is 3%. How much is your commission?
3% = 0.03
0.03 x $130,000 = $3,900
Here are some basic units of measure that you should commit to memory:
1 foot = 12 inches
1 yard = 3 feet
1 Square yard = 9 feet
1 acre = 43,560 square feet
(Helpful hint: Something that helped me remember it was my real estate professor told us to think of the store Seven Eleven to remember how many feet are in an acre, 4+3=7 and 5+6=11 so on acre is 43,560.)
1 mile = 5,280 feet
1 square mile = 640 acres (5,280ft (1 mile) x 5,280ft (1 mile) = 27,878,400ft ÷ 43,560ft (1 acre) = 640 acres.
(You probably don’t need to commit the square mile to memory but understanding how it’s calculated is good to know.)
Financial Math in Real Estate
As a real estate agent you will have many conversations with loan officers. Some of the common terms you will hear include interest rates, LTV, discount points and debt to equity income. Below, I give a few examples of each of these and try show the relevance to real estate agents.
Probably the most common term you will hear is interest rate. Every loan will most likely have an interest rate. The interest income generated from the loan is a vital source of revenue for the lender. For the borrower, it is cost associated with borrowing money. Let’s look at some examples of calculating simple interest:
Your buyer wants to borrow $100,000 to purchase their home and the lender is charging 4.5% interest per year. How much will your buyer pay in interest the first year of the loan?
$100,000 x 4.5% = $100,000 x 0.045 = $4,500 of interest the first year.
Since educators like to mix things up on exams let’s change things around a bit:
If we know that your borrower is being charged $9,000 for her first year of interest on a loan of $225,000, then what is the interest rate the lender is charging?
$9,000 (interest) divided by $225,000 (loan amount)= 0.04 = 4.0%
LOAN TO VALUE RATIO
LTV stands for Loan to Value. Lenders are concerned with how much money they will lend your borrower as a percentage of the appraised value of the desired home.
For example, if your borrower wants to buy a home for $100,000 and has $5,000 available to use as a down payment, the bank will have to lend $95,000 ($100,000 minus $5,000) for the loan to happen.
The Loan to Value calculation will be:
$95,000 (loan amount) divided by $100,000 purchase price = 95% LTV
Let’s think about it a different way:
If your buyer wants to purchase a $300,000 home and the lender will lend up to 90% of the loan, how much will your borrower need as a down payment?
$300,000 x 90% = $280,000 loan amount
$300,000 (purchase price) – $280,000 (loan amount) = $20,000 needed for a down payment.
Real life, however may not always be so clean cut. Let’s use the example above and say that the sales contract was written with a $100,000 sale price but the appraised value is comes $97,000. What does this mean to the buyer?
It’s likely the lender will only finance up to the appraised value of $97,000 minus any required down payment. So, if the lender requires 5% down payment and the house appraised for $97,000 what are the buyers options?
The buyer can walk away from the contract which can mean the loss of earnest money and/or any due diligence/option fees already paid.
The buyer can go back to the seller and ask to renegotiate since the house did not appraise for the asking price.
The buyer can go ahead with the contract as it stands and come up with the difference needed to make the deal happen. So let’s calculate what the buyer will need to do this:
Appraised value = $97,000
Bank requires 5% down payment = 5% x $97,000 = $4,850 from buyer
To satisfy the contract the buyer will need to make up the difference between the appraised value and the contract price. $100,000 (contract price) – $97,000 (appraised value) = $3,000
So the buyer will need to bring to closing $4,850 + $3,000 = $7,850
DEBT TO INCOME RATIO
The debt to income ratio is a great calculation that every buyer should be aware of and know how to calculate. It will help them understand how much of a monthly home payment they can afford and still buy groceries and pay other bills. It compares the gross income with the recurring debt (car payments, child support, student loans, etc).
If your buyer’s annual gross income is $65,000 and is using a lender that has a limit of 31% of income used for housing and a 43% total monthly debt limit, what is their maximum monthly house payment they can have and how much additional debt will the lender allow?
Housing Calculation (31%) – $65,000 x 31% = $20,150 / 12 months = $1,679
Total Debt Calculation (43%) – $65,000 x 43% – $27,950 / 12 months = $2,329
Total Allowable Debt $2,329 – Housing Debt $1,679 = $650 remaining for other Debt
What if the buyer above has $1,100 in monthly debt? How much will the lender allow for monthly house payments?
Total Allowable Debt $2,329 – $1,100 monthly debt = $1,229 remaining for housing.
Thank you for stopping by and reading this post. I hope it was helpful, and welcome your questions. Please leave comments on how I can make it better and more useful to you. Real Estate math can be a big stumbling block for people. My goal is to make it easier for people to understand and put it into practice.