Understanding The Mortgage Constant

Having a plan in place to pay off your mortgage loan over time is an important component of homeownership. Mortgages are serious financial commitments, and it’s essential for homeowners to make sure they’re able to keep up with their monthly payments to avoid mortgage default or even foreclosure on their property.

There are a few terms related to mortgage payments that can be useful for homeowners to be familiar with as they establish their repayment plan. One of these terms is “mortgage constant.”

What Is A Mortgage Constant?

A more specific type of loan constant, a mortgage constant is the percentage of a total fixed-rate mortgage loan amount that’s being paid off each year by the borrower. It can be helpful for loan borrowers to have an accurate sense of their mortgage constant in order to understand how much of their mortgage they’re paying off annually, and to make sure they have enough cash flow to be able to cover the amount they’re expected to pay each year.

For mortgage lenders, mortgage constant calculations can be used to help determine whether a prospective borrower has enough income to afford an estimated level of loan repayment each year and how high of a risk it would be to approve them for a mortgage. For real estate investors, determining their mortgage constant can play a role in their assessment of whether the property they’re investing in will be profitable for them.

It’s important to note, however, that mortgage constants cannot be applied to variable-rate mortgages, as the fluctuations in the interest rate over the lifetime of the mortgage loan make it impossible to accurately predict future debt services or constants.

How To Calculate Your Mortgage Constant

Homeowners and real estate investors have a few tools at their disposal to help them determine their mortgage constant. Let’s look at two of the most effective methods.

The Mortgage Constant Formula

The mortgage constant formula looks like this:

Mortgage constant = (annual debt service / total loan amount) x 100

Let’s break that down further. To determine what your annual mortgage constant is, add the cost of your monthly payments for an entire year of your mortgage (more commonly referred to as your annual debt service, which can be calculated using your principal, interest rate and amortization schedule), and then divide that number by your total loan amount. From there, multiply the resulting decimal by 100 to determine the percentage of your debt service that’s being paid each year. Make sure to never include property taxes and insurance in your monthly payment. Only use principal and interest monthly payments to determine your mortgage constant.

Here’s an example to help you get started. First, you’ll need to determine your monthly mortgage payment. If you’re still shopping for homes, you can estimate your monthly mortgage bill by using our mortgage calculator.

Hypothetically, let’s say you have a monthly mortgage principal and interest payment of $1,800 and a total loan amount of $320,000. By multiplying your monthly bill by 12, you’ll get an annual debt service of $21,600. Then, divide $21,600 by your total mortgage amount, $320,000, to get 0.0675. That value is your mortgage constant in decimal form. Slide the decimal two places to the right, and you’ll get your final answer: a mortgage constant of 6.75%.

Mortgage Constant Tables

Mortgage constant tables are another way to determine the percentage of your mortgage that you’re paying off each year. Constant tables include predetermined mortgage constant percentages, making them a great option for those who would prefer to avoid a manual calculation.

Most constant charts include the mortgage term length on one axis and the fixed interest rate on another. To use the table, identify the interest rate and amortizing loan period that matches your mortgage and locate the cell where the two variables intersect.

Using a table to determine constant percentages is less common today, thanks to mortgage calculators that make it even easier to make financial computations.

Mortgage Constant Vs. Cap Rate

While the mortgage constant shows the relationship between a borrower’s annual debt service and their total loan amount, the cap rate (or “capitalization rate”) shows the relationship between annual income and the total loan amount. Calculating the cap rate and comparing it against the mortgage constant can be particularly useful for real estate investors, as it can help them determine the rate of return on their investment and whether the net income accrued from their investment property is worth it.

To calculate your cap rate, take the annual net income from the investment property and divide it by the total mortgage loan amount. If the resulting percentage for the cap rate is higher than the mortgage constant, the property is profitable for the investor.

The Bottom Line

Knowing the mortgage constant for the mortgage loan you have on your home can help you establish a strategic repayment plan that aligns well with the rest of your financial obligations. For lenders and investors, mortgage constants can be a valuable numerical indicator of whether a potential investment opportunity is worth the risk.

Have more questions about your mortgage? Check out our Learning Center for more information on managing your home loan.