What Is a Loan Constant?
Let me explain what a loan constant is—it's a percentage that indicates the annual debt service on a loan relative to its total principal value. You calculate it by dividing the annual debt service by the total loan amount. When you're out there shopping for a loan, you can use this to compare different options. The one with the lowest loan constant means you'll have lower debt service requirements, so you'll pay less in interest and principal over time. Remember, this only applies to fixed interest rate loans, not those with variable rates.
Key Takeaways
A loan constant shows the annual debt service of a loan as a percentage of its total principal. You use the principal, loan interest rate, length of payments, and payment frequency to calculate it. Loan constant tables and calculators are commonly used for figuring out mortgage payments. When choosing a loan, you'll often go for the one with the lowest constant because it means lower debt service payments.
How a Loan Constant Works
A loan constant compares a loan's annual debt service to its total principal. Debt service is the total cash you need to pay to cover interest and principal repayment for a given period. It's expressed as a percentage and works for all types of loans. This helps you and analysts understand the loan factors better and see how much you're paying annually compared to the principal.
Fast Fact
A mortgage constant is simply a loan constant specific to real estate loans.
Calculating a Loan Constant
To calculate the loan constant, you need to get the loan terms from the lender, including total principal, interest rate, payment length, and frequency. With these, you can figure out the monthly payments using a present-value calculation. Then, use this equation: Loan Constant = Annual Debt Service / Total Loan Amount. For instance, if you have a $150,000 loan at 6% fixed interest over 30 years with monthly payments, the monthly payment is $899.33, making annual debt service $10,791.96. That gives a loan constant of 7.2% or $10,791.96 divided by $150,000.
Special Considerations
If you multiply the loan constant by the original principal, you get the annual periodic payments amount. You can use it to compare the true cost of borrowing. It's only for fixed-rate loans since variable rates change the annual debt service. Given two loans, you'll pick the one with the lower constant for lower debt service.
Loan Constant Tables
Before financial calculators, loan constant tables were popular in real estate for calculating monthly mortgage payments easily. These tables give prepopulated info based on a quoted loan constant. Using the earlier example, with a 7.2% constant, you could look it up to find the 6% interest rate and 360 monthly payments without other inputs. This concept is key in commercial real estate—compare it to the capitalization rate to see if you'll make or lose money on the financed part. For example, with a 7% cap rate and 6% loan constant on an apartment building, you earn 1% on borrowed money and 7% on equity. But if the constant is 7.5%, you lose 0.5% on the mortgaged portion.
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