Defining mortgage constants: Calculation and use cases

Quick insights

• Mortgage constants can help you make a like-for-like comparison of multiple loans or properties, even if there are differences in interest rate and loan term.
• Knowing this figure for several potential loans can be helpful for both individual homebuyers and real estate investors.
• While a mortgage constant is only one of several factors to consider when buying property, a lower constant indicates better cost-efficiency for a loan.

A mortgage constant, also known as a “loan constant,” is a financial metric that helps borrowers understand the relationship between what must be paid annually on the loan and its total amount. Knowing this constant can help with many kinds of comparisons, including running numbers for investment and affordability purposes.

In this article, we’ll further define mortgage constants, explain use cases and show you how to calculate this figure for yourself.

What is a mortgage constant?

A mortgage constant shows the annual debt service (principal plus interest) compared to the total loan amount. The figure is expressed as a percentage and shows how much of the loan must be repaid annually to keep up with the planned repayment.

Calculating the mortgage constant

The basic formula for a mortgage constant is annual debt service divided by the total loan amount:

Annual Debt Service / Total Loan Amount = Mortgage Constant

Calculating annual debt service is relatively straightforward—it’s the total amount of principal and interest payments made in one year. For example, the monthly payment on a $200,000 mortgage with 5% fixed interest rate is $1,073.64. Over the course of a year, the payments will amount to an annual debt service of $12,883.68. Therefore:

$12,883.68 / $200,000 = 0.0644184 (6.4%)

Expressed as a percentage, the result is a mortgage constant of 6.4%.

Which is better: A lower or higher mortgage constant?

When comparing loans, a lower mortgage constant indicates more efficient repayment of the loan. What’s considered a “good” mortgage constant will vary depending on the type of property being discussed and the state of the market. For a sense of what’s good at any point, research current trends, compare multiple properties and potentially consult with a real estate professional.

What the mortgage constant makes clear

Multiple factors of potential properties or loans are important, such as interest rate, term and property price. All the numbers can make it difficult to tell which mortgage is the more advantageous choice.

Here’s how a mortgage constant can clarify a mortgage comparison:

• Standardization: The mortgage constant provides a standard way to compare loans in a like-for-like way, representing each loan with a single figure.
• Proportional insight: With this figure, it’s easier to understand what the proportion of the loan payments are in relation to the overall loan size.
• Focus on efficiency: Comparing multiple mortgage loans by their constants can demonstrate which is the most efficient to repay, a kind of value calculation.
• Simplified communication: This figure is an industry standard, often used by financial advisors and investment stakeholders when discussing loan options.

How the mortgage constant can be used

The mortgage constant for multiple properties or loans can be useful for individual homebuyers and investors alike.

Affordability and loan comparisons

For homebuyers, finding the mortgage constant for multiple potential properties (or loan estimates) can help clarify which will provide the best value. For example, loans for two different houses which vary in value may have different purchases prices, interest rates and monthly values; the home with the lower mortgage constant is more cost-effective. Similarly, quotes on the same house from two different lenders can be compared by the respective mortgage constants.

Investment analysis

For real estate investors, mortgage constants can provide profitability insights. Suppose an investor wants to assess a property’s potential profit. In addition to calculating the mortgage constant, they will also find the capitalization rate (or “cap rate”). The cap rate uses the property’s annual net operating income (NOI) divided by its purchase price. If the cap rate is higher than the mortgage constant, this suggests that the property’s income will potentially cover the debt service and generate profit.

In summary

Understanding how to calculate mortgage constants can be useful, whether you’re making comparisons for your first purchase, or you’re an experienced investor. A loan with a low constant is a more cost-efficient option, so calculating the mortgage constant can help improve your decision making. However, there are many factors to considering before buying property. If you’re preparing to buy a home soon, consider connecting with a Chase Home Lending Advisor to discuss your options.