Mortgage Constant What It Is How to Calculate Use It
Mortgage Constant: What It Is, How to Calculate & Use It
What Is a Mortgage Constant?
A mortgage constant is the percentage of money paid each year to service a debt compared to the total value of the loan. It helps determine the annual cash needed to service a mortgage loan.
Understanding a Mortgage Constant
A mortgage constant is the percentage of money paid to service debt annually divided by the total loan amount. It provides the annual percentage of the total loan paid each year. Borrowers prefer a lower mortgage constant for lower annual debt servicing costs.
Real estate investors use a mortgage constant when buying a property to ensure enough rental income covers the annual debt servicing cost. Lenders use the mortgage constant to determine if the borrower has enough income to cover it.
Calculating the Mortgage Constant
To calculate the mortgage constant, total the monthly mortgage payments for one year and divide by the total loan amount.
For example, a $300,000 mortgage with a 4% fixed interest rate has a monthly payment of $1,432. The total annual debt servicing cost is $17,184, and the mortgage constant is 5.7%.
Applications of the Mortgage Constant
The mortgage constant helps investors determine if a property will be profitable. Debt yield, the opposite of the mortgage constant, shows the percentage of annual income based on the loan amount.
Using our example, an investor buying a house to rent out with a monthly net operating income (NOI) of $1,600 has an annual net income of $19,200. The debt yield is 6.4%, higher than the mortgage constant, indicating a profitable investment.
The mortgage constant also helps banks/lenders determine if a borrower’s income can cover the debt servicing costs of the loan.
Is the Mortgage Constant the Same As the Mortgage Capitalization Rate?
Yes, the mortgage capitalization rate is another term for the mortgage constant.
Why Is the Mortgage Constant Rate Higher than the Loan’s Interest Rate?
The mortgage constant includes both principal and interest payments, while the loan’s interest rate ignores the monthly principal. Therefore, it is higher for an amortizing loan.
How Can the Mortgage Constant Be Used By Investors?
Real estate investors compare the mortgage constants of potential investments to choose the most attractive among them.
