The mortgage constant explained

When you’re looking at mortgage options for a real estate investment, interest rates and monthly payments aren’t the only factors to consider. To truly understand how much the loan will cost over time, you’ll want to know about something called the mortgage constant – a valuable tool that ties directly into mortgage amortization.

The mortgage constant is a percentage that indicates how much you’ll pay each year toward the loan, including both interest and principal, as a proportion of the total loan amount. Simply put, it helps investors understand how a loan is repaid over the loan term and the impact it has on the property's cash flow.

But how do you actually use the mortgage constant, and what else should you know? Great question – let’s dive into what a mortgage constant is, its formula, and why it matters.

What is a mortgage constant, and how does it work?

A mortgage constant is a number that shows how much of a home loan is paid off annually, including both principal and interest. It gives you a way to look at the annual cost of repaying the loan expressed as a percentage of the original loan amount.

It’s important to note that this number only applies to fixed-rate loans, since the payments stay the same over time. That means this calculation doesn’t work for adjustable-rate or variable mortgages, where payments can change.

This formula is commonly used by lenders, real estate investors, and developers to evaluate the risk and return of an investment. For property owners and buyers, it’s also a helpful way to see whether the rental income can comfortably cover the loan payments and still leave room for a profit.

Mortgage constants vs. other real estate metrics

The mortgage constant is just one component of a real estate investor's toolbox. Often referred to as real estate metrics, these tools work best when used in conjunction so that you can gain a more comprehensive insight into a property's financial potential.

Net operating income (NOI) vs. mortgage constant

In real estate investing, your goal is to make sure any property you buy turns a profit. After all, what's the point of investing if you're not earning a return? Net operating income, or NOI, helps you estimate how much money an investment property can make. To calculate the NOI, take the total income and subtract all property management costs such as maintenance and taxes. Also, make sure to include all forms of income, such as parking fees or laundry machines.

Because NOI doesn't account for your mortgage payment, investors can combine both metrics to gain more insight into the profitability of the deal. For example, let's say the net operating income from the property is sufficient to comfortably cover the annual loan cost (the mortgage constant). In that case, the investment is more likely to be profitable, sustainable, and worthwhile.

Since financing is a significant component of overall profitability, it's also a good idea to ask your lender the right questions before signing the loan agreement. Here's a list of questions to consider asking your mortgage lender.

Cap rates vs. mortgage constants

The capitalization rate, also known as the cap rate, is another real estate metric that helps investors evaluate investment opportunities. This formula helps estimate cash flow compared to the investment property's market value. Unlike the mortgage constant calculation, the cap rate is typically used when financing isn't involved.

Here's the cap rate formula:

NOI ÷ Current Market Value = Cap Rate (as a percentage)

If you need a mortgage to buy the investment property, you can combine both metrics to gain more insight into how your loan payments affect profitability. Generally speaking, if the cap rate is higher than the mortgage constant, it shows that the income from the property should be able to cover the loan payments while still generating a stream of income.

How to determine your home loan constant

To calculate your home loan constant, you’ll need to know your total loan amount and monthly payment.

You can use our mortgage calculator to help you figure out your monthly principal and interest payment, if you don’t know it already.

The mortgage constant formula

There are several ways to calculate the mortgage constant, including using an online calculator or a tool like Excel. However, if you prefer a hands-on approach, here's a simple formula you can use:

(Principal + Interest) × 12 ÷ Loan Amount = Mortgage Constant

The top part of the equation is referred to as your annual debt service. This is the total amount it would take to completely repay your loan in 1 year.

One thing to keep in mind is that the mortgage constant works a little differently than your amortization schedule. The loan constant is a fixed percentage that doesn’t change. However, if you look at your amortization schedule, you’ll see that at the beginning of the loan, you pay more toward interest and later on, more toward the principal.

Calculating the mortgage constant: An example

Here’s a simple example of how to calculate the mortgage constant.

Let's say you borrow $415,000 with a 30-year fixed mortgage at a 5.5% interest rate in Los Angeles. Based on a mortgage calculator, your estimated monthly principal and interest payment would be about $2,356.

To figure out the mortgage constant, plug the numbers into the formula:

($2,356 × 12) ÷ $415,000 = (0.0681 × 100) = 6.81%

Quick note: Make sure you only use your principal and interest amount, since this formula doesn’t include other housing costs like taxes or insurance.

You can then use this formula to compare different loan options or investment opportunities to determine which one is more profitable. Typically, a lower mortgage constant indicates a more profitable investment when comparing the two.

How to use your mortgage constant

To get a more complete picture of a potential investment, many investors compare the mortgage constant with the cap rate. The cap rate is typically used when you're buying a property with cash, while the mortgage constant helps you evaluate the deal if you're planning to finance it.

Comparing both numbers side by side can give you a better sense of whether the investment is actually worth your time and money.

Building on the same example from above, the property's current market value is $518,750, and you determine it generates $51,000 in net operating income (NOI) annually. (NOI is your rental income minus monthly expenses, multiplied by 12.)

Your cap rate calculation will look a little something like this:

$51,000 ÷ $518,750 = 0.0983, or about 9.83%

For simplicity, let’s round up to 10%.

Now, if we go back to the $415,000 mortgage constant calculation example, your monthly principal and interest payment is $2,356.

That means:

$2,356 × 12 = $28,272 per year

$28,272 ÷ $415,000 = 0.0681, or 6.81%

Compare the two:

Cap rate: 10%

Mortgage constant: 6.81%

Since the cap rate is a higher percentage than the mortgage constant, the property is likely to generate enough income to cover the mortgage and still leave room for profit. This is the type of spread that investors typically look for to ensure a positive cash flow.

Mortgage constants and residential vs. commercial mortgages

Whether you're just getting started in real estate or already managing a few properties, it's helpful to know that you can have up to 10 residential mortgages. This includes homes with up to four units each, which still count as single-family properties under federal guidelines. That means you could potentially finance up to 40 units without needing a commercial loan.

When you're juggling more than one loan, it's especially important to understand how your financing affects your profits. A tool like the mortgage constant can help you compare loan options, spot which properties might cost you more in loan payments, and make smarter choices for steady cash flow. Simply put, it can help you stay profitable and avoid taking on too much debt as your portfolio grows.

FAQ

Before jumping into any real estate investment, it’s crucial to weigh the risk and reward using key metrics such as the mortgage constant. And like many investors, you probably still have some questions. To help, we’ve answered a few of the most common ones below.

Why is the mortgage constant higher than the interest rate?

Since the mortgage constant takes both the loan’s principal and interest into consideration, it will always be higher than the interest rate on any amortized loan. The interest rate only factors in interest and not the loan’s principal.

Why is the mortgage constant important?

The mortgage constant is important because it helps determine the profitability and return on investment of your real estate purchase, if you're financing it. A lower mortgage constant usually means higher profitability.

Should the cap rate or mortgage constant be higher?

In general, the mortgage constant for a loan should be lower than the cap rate. When the cap rate is lower than the mortgage constant, the investment is likely to be unprofitable.

The bottom line: Mortgage constants help you understand your debt service costs

Real estate investing can be an exciting endeavor – but it also comes with risks and complexities. That’s why it’s important to evaluate each opportunity using real estate metrics like the mortgage constant. This simple formula helps you compare loan offers, understand the cost of financing, and figure out whether a property is truly profitable.

Crunching the numbers and comparing your options helps ensure the investment works for you.

Whether it’s your first rental or your 10th, Rocket Mortgage^® can help you take the guesswork out of investing.

Start your online application today with Rocket Mortgage and discover a mortgage solution suited to your goals, big or small.