Loan Constant: Mortgage Constant
2019-03-29
The loan constant, also known as the mortgage constant, is the calculation of the relationship between debt service and loan amount on a fixed rate commercial real estate loan. It is the percentage of the cash paid to service debt on an annual basis divided by the total loan amount.
Key takeaways
- The loan constant is the percentage of the cash paid to service debt on an annual basis divided by the total loan amount.
- You can calculate the loan constant by dividing the annual debt service by the total loan amount.
- The loan constant only applies to fixed-rate loans or mortgages.
- You can compare the loan constant against the property's capitalization rate to determine if the property is a profitable investment.
What is a Mortgage Constant in Commercial Real Estate Loans?
The loan constant, also known as the mortgage constant, is the calculation of the relationship between debt service and loan amount on a fixed-rate commercial real estate loan. It is the percentage of the cash paid to service debt on an annual basis divided by the total loan amount. Using the following formula, you can easily calculate the loan constant:
For example, a 20-year amortizing loan of $1,000,000 with a 6 percent interest rate would incur $85,972 in annual payments, and would lead to a loan constant of around 8.6%
$85,972/$1,000,000 = 8.5972%
The loan constant only applies to fixed-rate loans or mortgages. In the event that the interest rate is variable, there is no way to accurately predict the lifetime debt service on a loan. However, it may be possible to calculate a constant for those periods of the debt's life that the interest rate is locked in.
Loan Constant vs. Cap Rate
One way to determine if a property's loan constant will make it a profitable investment is to compare it against the property's capitalization rate, or cap rate, which can be determined using the formula below:
In general, a property that has a loan constant higher than its cap rate will lose money, a property that has a loan constant equal to its cap rate will break even, and a property that has a loan constant less than its cap rate will be profitable. For example, if the net operating income (NOI) of the property in the example above was $100,000 a year, it would have a cap rate of:
100,000/$1,000,000 = 10%
Since 10% is clearly higher than 8.6%, we can see that the example property is likely going to be at least somewhat profitable.
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Frequently asked questions
What is a loan constant?
A loan constant, also known as a mortgage constant, is a percentage which compares the entire amount of a loan by its annual debt service. In order to determine a property's loan constant, a borrower will need to know information including the term, interest rate, and amortization of a loan. In general, loans with lower loan constants are generally more profitable for borrowers.
However, the loan constant cannot be applied to adjustable or variable rate commercial mortgages, since the constant change in interest rates makes it impossible to determine an accurate loan constant. For similar reasons, the loan constant cannot effectively be applied to interest-only (I/O) loans.
How is a loan constant calculated?
The formula to determine a loan constant is:
Mortgage Constant = Annual Debt Service ÷ Loan Amount
For instance, a 20-year, fully amortizing loan of $2,000,000 with a 5% interest rate would incur $158,389 in payments each year, with a loan constant of 7.9%.
$158,389 ÷ $2,000,000 = 7.9%
If you only have the mortgage constant and the principal loan payment, you can multiply the mortgage constant by the principal in order to determine the monthly payment on the loan:
$2,000,000 x 7.9% = $158,000 (rounded)
What is the difference between a loan constant and a mortgage constant?
The loan constant, also known as the mortgage constant, is the calculation of the relationship between debt service and loan amount on a fixed-rate commercial real estate loan. It is the percentage of the cash paid to service debt on an annual basis divided by the total loan amount. The loan constant only applies to fixed-rate loans or mortgages. In the event that the interest rate is variable, there is no way to accurately predict the lifetime debt service on a loan.
In addition to DSCR, LTV, and debt yield, a loan constant is an important metric that lenders use to determine a property’s suitability for a commercial or multifamily loan. A loan constant can also be thought of the as a kind of cap rate for lenders. In order to determine a property's loan constant, a borrower will need to know information including the term, interest rate, and amortization of a loan. In general, loans with lower loan constants are generally more profitable for borrowers.
What factors affect a loan constant?
The loan constant is affected by the term, interest rate, and amortization of a loan. It cannot be applied to adjustable or variable rate commercial mortgages, since the constant change in interest rates makes it impossible to determine an accurate loan constant. For similar reasons, the loan constant cannot effectively be applied to interest-only (I/O) loans.
What is the formula for calculating a loan constant?
The formula to determine a loan constant is:
Mortgage Constant = Annual Debt Service ÷ Loan Amount
For instance, a 20-year, fully amortizing loan of $2,000,000 with a 5% interest rate would incur $158,389 in payments each year, with a loan constant of 7.9%.
$158,389 ÷ $2,000,000 = 7.9%
If you only have the mortgage constant and the principal loan payment, you can multiply the mortgage constant by the principal in order to determine the monthly payment on the loan:
$2,000,000 x 7.9% = $158,000 (rounded)
How does a loan constant help in evaluating a loan?
A loan constant is an important metric that lenders use to determine a property’s suitability for a commercial or multifamily loan. It compares the entire amount of a loan by its annual debt service, and can be thought of as a kind of cap rate for lenders. A lower loan constant is generally more profitable for borrowers.
However, the loan constant cannot be applied to adjustable or variable rate commercial mortgages, since the constant change in interest rates makes it impossible to determine an accurate loan constant. Similarly, the loan constant cannot effectively be applied to interest-only (I/O) loans.