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Choosing which mortgage to go with is a big decision. A home loan is likely the biggest loan you’ve ever taken out, and it will affect your credit and financial health for the term of the loan. It’s an exciting time, but you should choose wisely.
You’ll want to know the pace at which you’ll be paying off any mortgage loan to know if it’s a good investment. This is where the mortgage loan constant or mortgage constant comes in.
What Is a Mortgage Constant?
The mortgage constant is the percentage of the loan you’ll be paying off annually. It factors in the loan amount, interest rate and mortgage loan term to get an accurate picture of the pace at which you’ll be paying your mortgage lender back.
Why Does Your Mortgage Constant Matter?
Your mortgage constant can help you compare different loan options. Since the mortgage constant tells what percentage of the loan you’re paying off each year, you want to be looking for a loan with the highest percentage that’s still within your budget.
When Can You Use a Mortgage Constant?
An annual loan constant only applies to fixed-rate mortgage loans. These loans have a set annual debt service, which means you’re paying the same amount every year for the life of the loan.
Unlike fixed-rate mortgage loans, variable or adjustable-rate mortgages are recalculated on a regular basis. Because of this, the amount paid each year isn’t consistent, so a mortgage constant doesn’t apply.
Using the Mortgage Constant Formula
The mortgage constant formula may look intimidating, but it’s pretty straightforward. We’ll help you break down each portion to make it as approachable as possible.
Before we dig into the formula itself, let’s define a few mortgage variables that you’ll need to find your loan constant.
- Principal: This is your total loan amount.
- Interest rate: This is a percentage of your principal your lender charges you for lending you money.
- Mortgage term: This is the length of your mortgage – It could be a 10-year, 15-year, 25-year or 30-year mortgage.
- Monthly mortgage payment: This is how much you pay per month. The amount factors in both the principal and the interest, so your entire payment doesn’t go toward the principal.
- Annual debt service: This is how much you pay per year. To find this number, you simply multiply the monthly payment by 12 (months).
You can find any of these numbers easily when considering different loans. Don’t hesitate to ask your lender what each figure they give you means.
If you know your monthly mortgage payment:
If you know your monthly mortgage payment or annual debt service (monthly payment x 12), then you can jump right into this formula with your annual debt service and loan principal.
(Annual debt service / principal) X 100
If your monthly payment is about $1,000, then your annual debt service is about $12,000.
This monthly payment is on a 30-year fixed-rate mortgage for $230,000 at a 3.3% interest rate. For this $230,000 loan, divide 12,000 by 230,000, which is ~0.052.
Then, multiply that number by 100 to make it into a percentage: 0.052 x 100 is 5.2%.
So your mortgage constant would be 5.2%, meaning you’re paying off 5.2% of this loan annually.
If you don’t know your monthly mortgage payment:
If you don’t know your monthly mortgage payment or annual debt service, you can use our mortgage calculator to calculate it from your principal, interest and term. Once you find your monthly payment, you can jump to the formula above.
Using a Mortgage Constant Table
If you’d rather not find your mortgage constant manually, you can use a mortgage constant table (not to be confused with amortization tables). These are tables with predetermined mortgage constants for a list of variables. Many lenders offer these on their websites.
First, you’ll need to know your interest rate and loan term. Next, look at the axes and find your interest rate and loan term on them. Then find the cell where they intersect. That’s your mortgage constant.
Cap Rates vs. Mortgage Constants
While the cap rate, or capitalization rate, is often confused with the loan constant, they’re both used in different circumstances. Cap rates are specifically used for investment real estate, to compare the annual income and total loan amount.
Comparing the cap rate to the mortgage constant is valuable when considering if investment properties are going to be worth it for a real estate investor. If the cap rate is higher than the mortgage constant, then it’s a profitable investment.
A Simple Equation for Your Next Big Decision
The mortgage constant only takes a few minutes to find and gives you valuable information to evaluate your mortgage loan. Do the math and start comparing loans so you can find the best value for you!
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The Short Version
- The mortgage constant is the percentage of the loan you’ll be paying off annually
- You’ll need your annual debt service and your loan principal to manually calculate the mortgage constant
- It can help you compare different mortgage loans when choosing the right one for you