A mortgage constant is a percentage that shows the ratio of annual mortgage payments to the total amount of the mortgage loan. You can use this figure to decide whether you can afford a home, to compare various loan options, and to work out the total amount of debt you’re servicing annually.
Let’s take a look at what a mortgage constant is, how a mortgage constant works, and what it means for you.
Definition and Examples of Mortgage Constants
You can calculate a mortgage constant to figure out how much of your loan you’re paying off each year. This can be important information, not just for you, but for a potential lender. Banks can also use mortgage constants to decide whether or not to give you a loan.
Mortgage constants have a third implication for real estate investors. Investors can use a mortgage constant to determine whether or not an investment property may be profitable.
Be aware that mortgage constants can only be used for fixed-rate loans. Variable-rate loans have a fluctuating annual percentage rate and do not qualify for this calculation.
- Alternate names: loan constant, debt constant
How Mortgage Constants Work
So how does a mortgage constant work? To figure out the mortgage constant on your loan, you’ll need to do some math.
Let’s say that you’re looking at purchasing a home for $200,000. It’s a 30-year term, you’ve put $40,000 down, and your APR is 2.65%. Using a mortgage calculator, you can input all your information to determine your monthly mortgage payment.
Mortgage constants do not include property taxes or homeowners insurance, even if you’ve got an escrow account and they make up a portion of your mortgage payment. This is because those payments do not go toward servicing your loan.
With these terms, your monthly mortgage payment comes out to $644.74 per month.
The formula for the mortgage constant is simple:
Mortgage constant = (Annual mortgage debt service / Total loan amount) x 100
To find your annual debt service, multiply $644.74 by 12—that’s the number of payments you make each year. The result is $7,736.88. This is what you pay toward both principal and interest, but not other mortgage payment components such as taxes and insurance.
Next, divide $7,736.88 by your total loan amount, which is $160,000. You’ll be left with 0.048. Multiply that by 100 to get a percentage: 4.8%. This means you’re paying off a total of 4.8% of your loan each year.
Your mortgage constant is 4.8%.
If you’re already paying a loan, simply multiply your existing mortgage payment by 12, then divide it by your total loan to calculate your mortgage constant.
What It Means for You
How does this apply to you? A mortgage constant can be helpful when it comes time to purchase a home. It can help you understand the total financial cost per year and help you decide if that’s something you can afford. You can also use it to compare different loan options. While a monthly payment gives you a decent idea of costs, a mortgage constant provides a bigger picture.
If you already own a home, calculating your mortgage constant can help you understand your cash flow and aid with budgeting. This may be of particular help if you want to pay off your mortgage early. By using the calculations above, you can figure out how your mortgage constant will vary by making additional payments.
Otherwise, if you’re looking to invest in a real estate property, knowing your mortgage constant can be a helpful indicator as to whether or not it’s worth investing. You can determine this by comparing your mortgage constant to the annual net income you expect to earn—the capitalization rate. This formula works a lot like the mortgage constant: Divide net income from the property by the loan amount. If the capitalization rate is higher than the mortgage constant, the investment is likely to be a profitable one.
- A mortgage constant is used to calculate how much of your debt you’re servicing each year.
- You calculate a mortgage constant by multiplying your monthly payments by 12, then dividing that number by your total loan amount.
- Mortgage constants can be helpful for homeowners or prospective buyers to understand their cash flow and whether they can afford a home.