The Mortgage Constant Explained: What It Is And How It Affects Your Home Loan
Kevin Graham5-minute read
September 30, 2021
If you’re evaluating several different home loan options, one of the big questions you might be looking to answer is the pace at which you’d be paying off your loan if you make all of your payments based on the schedule associated with your loan. The mortgage constant answers that question. Before we get into the details, let’s start with what it is.
What Is A Mortgage Constant, And How Does It Work?
A loan constant tells you how much of the loan is being paid off each year over the course of the term. There’s no such constant with variable- or adjustable-rate loans because the payment is recalculated over the remainder of the term each time the rate adjusts. The change means there’s no consistent amount being paid off each year.
A mortgage constant is a specific type of loan constant which looks at how much debt is paid off per year on fixed-rate mortgage loans.
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Why Do Mortgage Constants Matter?
Mortgage constants are important because they’re one way of evaluating whether something is a good investment, for all sides of the transaction. Mortgage lenders and the loan investors who help fund their loans want to know how much they’re being paid back each year. Home buyers, real estate investors and homeowners want to know this when evaluating their loan options.
Real estate investors can also use this with other metrics such as net operating income to help them determine whether a rental is profitable based on the loan terms they’re being offered. If the rate of return they’re getting each year compared to the loan amount (also referred to as debt yield) is higher than the mortgage constant, the investment is profitable.
How To Determine Your Home Loan Constant
In order to calculate your home loan constant, you’ll need to know your monthly payment. Although there are ways to do that if you know the loan balance, interest rate and term, unless you have a great love for Excel formulas, the easiest thing for most people is to use a mortgage calculator. This will help you figure out your monthly principal and interest payment.
The Mortgage Constant Formula
There are a couple of ways to calculate the mortgage constant. Let’s first go over a formula where you only need the mortgage rate and the loan term.
Mortgage Rate/ [ 1 - [ 1 / (1 + Mortgage Rate) x Mortgage Term in Months]]
There are a couple of variables here, so let’s touch on them.
- Interest rate: Because the interest rate associated with your mortgage is quoted annually, in order to get the amount of interest you pay monthly, you’re going to divide by 12.
- Mortgage term: Because the formula is based on monthly interest, you also need to quote your mortgage term in months, so you’re going to multiply your term by 12.
If you know what your monthly payment is, it’s a much easier formula to calculate the mortgage constant. All you need is your principal and interest payment and your loan amount. The formula is as follows.
(Principal + Interest) ×12
The numerator in that equation is referred to as your annual debt service. One thing to keep in mind here is that the mortgage constant works a little bit differently than your amortization schedule.
The constant is a fixed percentage that doesn’t change. However, if you look at your amortization schedule, at the beginning of the loan you pay more toward interest and then you pay more toward the principal later on.
Calculating The Mortgage Constant
Now that we know the variables, let’s run through an example of calculating the mortgage constant both ways. Let’s say you have a $300,000 loan amount for a 30-year fixed loan at 3.5% interest.
Let’s take the formula that only relies on the interest rate and mortgage term first. You would plug in the numbers like this:
(.035/12)/ [ 1 - [ 1 / (1 + ((.035/12) x 360)]]
This is much easier if you have some talent with Excel formulas. However, take our word for it that it comes out to about 5.389%.
If you use the second formula by getting a monthly principal and interest payment from a mortgage calculator, it comes out to the following:
(1347.13 × 12)/300,000
That also comes out to about 5.389%. It’s also much easier to put into a calculator. The only word of caution with this one is that you should only be including your principal and interest payment and not your taxes and insurance.
Mortgage Constant Tables
Knowing how to do the math is nice, but not having to do math is better. I apologize to every math teacher I’ve ever had, but it’s not my favorite subject. Anyway, there are tables that allow you to find the mortgage constant without having to do any mental gymnastics.
All you need to know is your annual mortgage rate and your loan term. From there, use a table to find the mortgage constant.
The Difference Between Cap Rates And Mortgage Constants
Capitalization rates are another way to determine how well a real estate investment works. To get your cap rate, you take your net operating income for the year and divide by the market value of the property. It gets a little more complicated because investors have to not only consider how much they are charging for rent, but also a vacancy factor and taxes.
In the next section, we’ll take a look at how you can use both of these metrics in concert to see whether something is a good investment based on returns.
How To Use Your Mortgage Constant: An Example
Let’s presume that you have an annual income of $36,000 from a property that’s worth $300,000 with the same 30-year mortgage. Your cap rate is 12%.
Now let’s assume you wanted to know whether it was a good investment and you want to compare it to your mortgage constant to determine your profit. When you subtract the mortgage constant from earlier, you’re still making a 6% annual return on the investment. Obviously, the higher the better, but this is another way of looking at profitability.
The Bottom Line: Mortgage Constants Help Homeowners Strategize Their Payments
A mortgage constant takes a look at how much of your mortgage would be paid off each year of your Long-Term if it were paid off at a constant rate. This only works with fixed-rate loans. It’s also a little bit simplified because the amount paid toward interest and principal flips over time. However, it does give you an idea of how much you’re putting toward debt to determine if something is a good investment.
A similar measure is cap rate, something real estate investors use to compare net operating income to the market value of the property. Combining the two metrics, you can subtract the mortgage constant from the cap rate to determine profitability.
If you’re interested in looking into your mortgage options, you can apply online. On the other hand, everything we’ve talked about assumes you make your payment according to the original schedule. However, there are different strategies you can undertake. Feel free to consider your mortgage payment options.