Mortgage Constant Definition

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Mortgage Constant Definition

What Is a Mortgage Constant?

The amount paid annually to settle or service a debt in relation to the total loan amount is known as the mortgage constant. The yearly amount of cash required to service a mortgage debt may be calculated with the aid of the mortgage constant.

It is determined by dividing the yearly loan debt service by the entire loan amount.

Key Takeaways

  • The proportion of money paid annually to settle or service a debt based on the total loan amount is known as a mortgage constant.
  • The yearly amount of cash required to service a mortgage debt may be calculated with the aid of the mortgage constant.
  • Lenders and real estate investors use the mortgage constant to calculate if there is sufficient revenue to pay the loan’s yearly debt service charges.
  • It is often referred to as the capitalization rate for mortgages.

Understanding a Mortgage Constant

The yearly proportion of money paid to service debt divided by the total loan amount is known as a mortgage constant. Since the outcome is given as a percentage, it shows what portion of the entire debt is repaid annually. Borrowers may estimate their annual mortgage payment using the mortgage constant. Since a lower mortgage constant would result in a lower yearly debt service expense, the borrower would prefer it.

When obtaining a mortgage to purchase a property, real estate investors employ a mortgage constant. The investor will need to make sure that the rent is high enough to meet the yearly cost of mortgage loan debt service. In order to establish if the borrower has sufficient income to pay the mortgage constant, banks and commercial lenders utilize the mortgage constant as a debt-coverage ratio.

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Calculating the Mortgage Constant

We would add up the monthly payments for the mortgage over the course of a year and divide the total by the loan amount to get the mortgage constant.

A $300,000 mortgage, for instance, has a $1,432 monthly payment at a 4% annual fixed interest rate. You may see the effect of various rates on your monthly payment with a mortgage calculator.

  • The entire yearly cost of debt service is $17,184 (12 months * $1,432)
  • 5.7% = ($17,184 / $300,000) is the mortgage constant.

Since it is impossible to anticipate the lifetime debt payment of a variable-rate loan, the mortgage constant only applies to fixed-rate mortgages, but one might compute it for any time periods with a locked-in interest rate.

Applications of the Mortgage Constant

Real estate investors may use a mortgage constant to determine if a property will be a lucrative investment since it can provide this information. The mortgage constant is the reverse of debt yield. Debt yield displays the proportion of yearly revenue depending on the total amount of the mortgage loan. When the cash flow is positive and the debt yield exceeds the mortgage constant, the investment is profitable.

Let’s imagine an investor wants to purchase the home in the prior case in order to rent it out. The rental property is anticipated to generate a monthly net operating income (NOI) of $1,600. Rent is deducted from monthly costs to determine net income. From our last example, the loan amount to buy the home was $300,000.

  • $1,600 divided by 12 months is $19,200 in net income annually.
  • By dividing the $300,000 loan amount by the $19,200 net operational revenue each year, the debt yield is found to be 6.4%.
  • Remembering that the mortgage constant was 5.7%, an investment in debt would be advantageous since the debt yield is larger than the constant.
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In other words, the property’s yearly net income is sufficient to pay the mortgage constant or the cost of debt service. As previously mentioned, banks or lenders may also utilize the mortgage constant to ascertain if a borrower has the yearly income necessary to pay the loan’s debt service expenses.

The lender would use the borrower’s monthly income in place of the monthly rental revenue when doing the computation in the same manner as before. The borrower’s monthly net income, or the amount of money left over after paying for bills and other monthly debt obligations, would need to be determined by the bank. The lender might then figure out whether the yearly net income and debt yield are sufficient to pay the mortgage constant.

Is the Mortgage Constant the Same As the Mortgage Capitalization Rate?

Yes. The mortgage constant is also known as the capitalization rate for mortgages.

Why Is the Mortgage Constant Rate Higher than the Loan’s Interest Rate?

While the loan’s interest rate doesn’t take into account the monthly principle payments, the mortgage constant does. The former will be higher on an amortizing loan as a result.

How Can the Mortgage Constant Be Used By Investors?

Real estate investors will compare the mortgage rates of several possible investments to see which is more appealing (i.e., has the highest rates).

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