A loan is supposed to lift the return on your money, and it does, right up to the point where the building earns less than the loan costs. Past that point the loan works against you. The name for it is negative leverage, and it is the quiet reason a building can look fine on the listing and lose money every month.
What is negative leverage?
Leverage is using borrowed money so your own cash controls a bigger asset. Whether that helps depends on one comparison: what the property earns on its full price, against what the loan charges on the part it covers.
Earn more than the loan costs and the difference belongs to you, spread over a smaller pile of your own cash, so your return rises. Earn less and you are making up the shortfall out of pocket every month. Same loan, opposite effect.
Why does a 7% loan cost 8% a year?
Because a mortgage payment covers more than interest. Every payment also hands back a slice of principal, and the money has to come from somewhere whether the lender calls it interest or not.
A $560,000 loan at 7% over 30 years costs $3,726 a month, which is $44,708 a year, which is 7.98% of the loan. That percentage is the loan constant: a year of payments divided by the amount borrowed. It is the number to put next to a cap rate, because a cap rate is also a yearly figure measured against a price.
The constant always sits above the interest rate, and the shorter the loan the wider the gap. At 6% over 30 years it is 7.2%. At 5% it is 6.4%. At 8% it is 8.8%.
The same fourplex at $499,000 and $700,000
Take four units renting for $1,575 each, $6,300 a month, bought with 20% down on a 30-year loan at 7%. Vacancy runs at 6%, the building pays $450 a month for water, trash and common areas, and repairs and management take 10% and 8% of the rent. The example scales the tax bill and the insurance premium with the price, since both track what the building is worth, and leaves the rents exactly where they are.
| $499,000 | $700,000 | |
|---|---|---|
| Rent | $6,300 | $6,300 |
| Empty units (6% of rent) | −$378 | −$378 |
| Property taxes | −$533 | −$748 |
| Insurance | −$300 | −$421 |
| Water, trash and common areas | −$450 | −$450 |
| Repairs and big repairs (10% of rent) | −$630 | −$630 |
| Property management (8% of rent) | −$504 | −$504 |
| Mortgage (principal and interest) | −$2,656 | −$3,726 |
| Cash flow each month | +$849 | −$557 |
These are example figures, not a forecast for any market.
Nothing about the building changed. The rents are identical, the tenants are the same tenants, the roof is the same roof. Only the price moved, and $849 a month became a $557 hole.
Here is the same pair read as returns.
| $499,000 | $700,000 | |
|---|---|---|
| Net operating income | $42,056 | $38,028 |
| Cap rate | 8.4% | 5.4% |
| What the loan costs a year | 8.0% | 8.0% |
| Cash-on-cash return, 20% down | 8.9% | −4.1% |
| Cash-on-cash return, all cash | 8.2% | 5.3% |
| Debt coverage (DSCR) | 1.32 | 0.85 |
Read the bottom two rows against each other. At $499,000 borrowing beats paying cash, 8.9% against 8.2%. At $700,000 paying cash returns 5.3% and borrowing returns a 4.1% loss, so the loan costs you 9.4 points of return. That gap is negative leverage, and it is not a small effect.
The cap rate falls at the higher price for two reasons at once: the same income divided by a bigger number, and a bigger tax and insurance bill eating $4,028 a year of the income before the division happens. If net operating income is new to you, how to calculate NOI walks through it line by line.
Where exactly does borrowing stop helping?
At the price where the building, bought outright, returns what the loan costs. For this fourplex that is $509,000. Pay that and all cash returns 7.98%, borrowing returns 7.98%, and the loan charges 7.98%. It has become decoration.
The rough version of the same test is the cap rate against the loan constant, which is what most people use and which gets you close: 8.4% against 8.0% says borrowing helps, 5.4% against 8.0% says it hurts. The reason the two tests do not land on the same dollar is closing costs. A cap rate divides income by the price, while a cash-on-cash return divides it by every dollar you put in, and the 3% of closing costs in this example is part of that second figure and none of the first. Cap rate and cash-on-cash sets the two side by side.
What does negative leverage do to the loan itself?
It breaks the test the lender runs. Debt coverage is net operating income divided by a year of payments, and on this building it falls from 1.32 to 0.85. Anything under 1.00 means the income does not cover the payments, which is the same fact the cash flow row already told you, stated the way a lender states it. The calculator shows that figure as Debt coverage (DSCR), and what counts as a good DSCR covers where lenders draw their line.
In practice a building at 0.85 does not get the loan at all, which is its own kind of protection. The dangerous version is a deal that clears the lender’s test by a hair and still returns less than paying cash would.
Does a bigger down payment fix it?
It shrinks the damage without removing it. Put 25% down on the $700,000 version and the monthly loss improves from $557 to $324, and the return from a 4.1% loss to a 2.0% loss. Still negative, because the loan still costs 8.0% a year and the building still earns 5.4%.
More down is also not optional on a building you will not live in. Freddie Mac’s limit for a two to four unit investment property is 75% of the price, which is 25% down before a lender adds anything of its own, so the 20% in the table assumes you occupy one of the units.
Only three things actually move the comparison: a lower price, higher net operating income, or a cheaper loan. Rates are the one you do not control. Freddie Mac’s weekly survey had the 30-year average at 7.32% as of October 22, 2026, and a 30-year loan at that rate costs 8.2% a year, so a building has to clear 8.2% on its price before the loan adds a thing.
So price the loan before you price the building. Work out the loan constant for the terms you have been quoted, then open the multifamily calculator, type the asking price and the real rents, and see which side of that number the cap rate lands on. If it lands below, the fix is the offer, not the financing. How to analyze a multifamily property covers the rest of the inputs.