How to Lower the Debt to Equity Ratio by Renting Out a Home
Debt to equity ratio refers to how much debt a person carries per unit of equity. Lowering the debt to equity ratio works by increasing the total amount of equity. This happens when the home is rented or leased for a certain amount of time. Because this turns the property into a receivable account, it becomes an asset. Because of this new asset, the total amount of equity is increased because the total asset amount for the property owner increases.
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Instructions
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Lease the property to a renter for a mutually agreed period. For example, the property owner rents out a single-family home for 12 months for $1,200 per month. The property owner owes $150,000 to the mortgage company on the property. The home is worth $175,000. The property owner possesses a total of $450,000 in assets including the home, and carries a total of $350,000 in debt.
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Determine the current debt to equity ratio by deducting the debt from the assets. In this example, $450,000 in assets minus $350,000 in liabilities equals $100,000 in total equity. The current equity ratio is therefore, $100,000 to $350,000 or 1:3.5. For every $1 of equity, there is $3.50 in debt.
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Multiply the monthly lease amount by the number of months the home is leased for. Continuing the example, $1,200 multiplied by 12 months equals $14,400. The total amount of rental income expected becomes the account receivable and an asset.
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Add the account receivable to the total amount of assets. Continuing the example, $14,400 plus the current $450,000 in current assets equals $464,400 in total assets.
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Determine the new equity to debt ratio. Continuing the example, $464,000 in total assets minus $350,000 in debt equals $114,400 in equity. So the new ratio is now $114,400 over $350,000 or 1.14:3.5 as there is now $1.14 for every $3.50 in debt.
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References
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