What is a Mortgage Constant
A mortgage constant is a ratio of the annual amount of debt servicing to the total value of the loan. The mortgage constant is only applicable to mortgages that pay a fixed rate. A mortgage constant is also known as the "mortgage capitalization rate."
BREAKING DOWN Mortgage Constant
A mortgage constant is essentially the percentage of money paid to service debt on an annual basis divided by the total loan amount. It is the capitalization rate for debt and it is computed monthly by dividing the monthly payment by the mortgage principal. An annualized mortgage constant can be computed by multiplying the monthly constant by 12. Mortgage constant is a rate that appraisers determine for use in the band of investment approach; additionally, many commercial bankers users it along with the debt-coverage ratio. The mortgage constant only applies to fixed-rate mortgages because there is no way to predict the lifetime debt service on a loan accurately. However, it may be possible to calculate a constant for the periods of the debt's life that has a locked in interested rate.
A mortgage constant is a useful tool for real estate investors because it clearly shows how much the borrower will need to pay over a given period of time. Because a mortgage constant is the lender's capitalization rate, it could also be very helpful for a lender to calculate their mortgage constant. If a lender multiplies their mortgage constant by the loan-to-value ratio percentage, the resulting figure needs to be less than the capitalization rate in order to get a positive cash flow. This tool can assist lenders in making strategic moves that can result in more capital.
A mortgage constant can also be used to calculate the highest loan value that could be received on a property given the income generated by that property if it is a commercial or rental property. For example, if the total amount paid annually on a $200,000 loan is $5,000, the mortgage constant would be 5,000 / 200,000 = .025, or 2.5%.
Calculating a Mortgage Constant
The mortgage constant is denoted as Rm. The Rm is higher than the interest rate for an amortizing loan because the Rm includes consideration of the principal as well as the interest. The Rm could be lower than the interest for a negatively amortizing loan.
The formula for computing a mortgage constant is as follows:
- i = Interest
- n = Total Number of Months that the loan is repaid
- m = Number of months the loan is paid in a year