Enter your project cost and equity contribution above.
Understanding the Rule of 80
The "Rule of 80" is a financial guideline primarily used in the context of lending, especially for commercial real estate or business acquisitions, though its principles can be applied more broadly to assess financial leverage. It helps lenders or investors quickly evaluate the risk associated with a loan or investment by looking at the combined loan-to-value (LTV) or debt-to-cost (DTC) ratio.
The Math Behind the Rule of 80
The core concept is simple: The total of the loan amount and the borrower's equity contribution should not exceed 80% of the total project cost or asset value, or conversely, the loan amount should not exceed 80% of the asset's value. A more common interpretation, especially in a borrowing context, is that the Debt Service Coverage Ratio (DSCR) should be at least 1.20 (or 120%), which is the inverse of 80%. However, when used as a direct leverage metric, it means:
Maximum Loan Amount = Total Project Cost * 0.80
This implies that the borrower's equity must be at least 20% of the Total Project Cost.
In the context of this calculator, we are evaluating the leverage applied to a project. If the equity contribution is less than 20% of the total project cost, the implied loan-to-cost ratio would exceed 80%, potentially making the project riskier or harder to finance under traditional lending standards.
How to Use This Calculator
1. Total Project Cost: Enter the full estimated cost of the project or asset you are considering. This includes purchase price, renovation costs, fees, etc.
2. Your Equity Contribution: Enter the amount of your own funds you plan to contribute to the project. This is the down payment or direct investment you are making.
3. Calculate: Click the "Calculate" button.
Interpreting the Results
The calculator will tell you if your equity contribution meets or exceeds the 20% requirement implied by the Rule of 80.
Meets Rule of 80 (or Exceeds): If your equity contribution is 20% or more of the total project cost, the implied loan-to-cost ratio is 80% or less. This generally indicates a favorable leverage position, which is often preferred by lenders.
Does Not Meet Rule of 80: If your equity contribution is less than 20% of the total project cost, the implied loan-to-cost ratio is greater than 80%. This suggests higher leverage, which might be seen as riskier by lenders and could lead to less favorable loan terms or difficulty securing financing.
Example Scenario
Let's say you are looking to purchase a commercial property for $500,000 (Total Project Cost). You plan to contribute $120,000 in equity.
Since 24% is greater than the 20% required by the Rule of 80, this scenario generally aligns with the guideline. The implied loan amount would be $380,000 ($500,000 – $120,000), resulting in a Loan-to-Cost ratio of 76% ($380,000 / $500,000), which is less than 80%.
Alternatively, if your equity was only $80,000 for the same $500,000 project:
In this case, 16% is less than 20%, meaning the implied loan amount ($420,000) would represent 84% of the project cost, exceeding the 80% threshold of the Rule of 80.
Disclaimer
The Rule of 80 is a guideline, not a strict rule. Lending decisions depend on many factors, including the borrower's creditworthiness, the specific asset, market conditions, and the lender's internal policies. Always consult with financial professionals for personalized advice.
function calculateRuleOf80() {
var projectCostInput = document.getElementById("projectCost");
var equityContributionInput = document.getElementById("equityContribution");
var resultDiv = document.getElementById("result");
var projectCost = parseFloat(projectCostInput.value);
var equityContribution = parseFloat(equityContributionInput.value);
if (isNaN(projectCost) || isNaN(equityContribution)) {
resultDiv.innerHTML = "Please enter valid numbers for both fields.";
return;
}
if (projectCost <= 0) {
resultDiv.innerHTML = "Total Project Cost must be greater than zero.";
return;
}
if (equityContribution projectCost) {
resultDiv.innerHTML = "Equity Contribution cannot exceed Total Project Cost.";
return;
}
var equityPercentage = (equityContribution / projectCost) * 100;
var impliedLoanToCostRatio = 100 – equityPercentage;
var message = "";
var messageClass = "";
if (equityPercentage >= 20) {
message = "Meets Rule of 80! Your equity contribution (" + equityPercentage.toFixed(2) + "%) meets or exceeds the 20% minimum. Implied Loan-to-Cost Ratio: " + impliedLoanToCostRatio.toFixed(2) + "%.";
messageClass = "success-message";
} else {
message = "Does Not Meet Rule of 80. Your equity contribution (" + equityPercentage.toFixed(2) + "%) is less than the 20% minimum. Implied Loan-to-Cost Ratio: " + impliedLoanToCostRatio.toFixed(2) + "%.";
messageClass = "alert-message";
}
resultDiv.innerHTML = "" + message + "";
}