Have a Mortgage? You Really Need to Calculate This Number
A mortgage constant, also referred to as the mortgage capitalization rate, is a percentage of the total loan paid each year. If you are in the market for a new home, this percentage can be useful for various reasons. For instance, it can help you better understand how much of your loan you are repaying each year. Buying real estate is a big portion of the financial picture for a lot of people, so you may want to talk to a financial advisor to help you create the right plan and balance across all of your financial investments.
What Is a Mortgage Constant?
A mortgage constant is a mathematical calculation that finds how much of a mortgage loan is being repaid over the course of its term. The formula uses the loan’s interest rate to determine the constant. As a result, it only works for fixed-rate mortgages since variable-rate mortgages don’t always have the same rate. This is intended to be a constant rate, so it won’t work if the numbers change throughout the life of the loan.
The mortgage constant is useful in helping borrowers ensure they can cover the cost of the mortgage. But it can also be helpful in other ways. For real estate investors, it can be a part of determining whether a property is a good investment. It can also help lenders determine whether a borrower can repay the mortgage given their income.
Calculating the Mortgage Constant
The mortgage constant calculation can be a bit complicated depending on the data available to you. The easiest calculation involves adding up your total monthly payments (including interest) for the year. This amount is commonly referred to as debt service. If you know your monthly payments, you can calculate your mortgage constant as simply:
Mortgage constant = (Monthly payment * 12) / total loan amount
Say you have a $285,000 mortgage with a monthly payment of $1,680. That results in total payments of $20,160 for the year. Divide that by the total loan amount and you have a mortgage constant of 7.07%.
Notice how this formula doesn’t include costs such as property taxes and insurance costs. We are only calculating the percentage of the mortgage repayment here, so taxes and insurance don’t enter the equation.
Mortgage Constant Tables
Calculating the mortgage constant can be complicated, especially if, for example, you only have the mortgage interest rate and the length of the term. However, there are several mortgage constant tables available online that have already done the work for you. Instead of having to calculate the mortgage constant yourself, all you need is the rate of the loan and the length of the term in years.
For example, you might find that one of these tables tells you that a 30-year loan with a 5.125% rate has a mortgage constant of 6.534%. Doing your own calculation can be useful to understand how it works, but it isn’t necessary if you can find a mortgage constant table that includes the particulars of your mortgage.
These tables are nevertheless a bit old-fashioned these days. Again, they can be a nice reference if you really want to see all the numbers laid out in front of you. However, using a mortgage calculator is usually easier and can provide a wealth of information.
What About Cap Rates?
One metric that is popular, particularly among real estate investors, is the cap rate. Although you might hear “mortgage capitalization rate” used to refer to the mortgage constant, there is a separate cap rate that real estate investors use to determine the profitability of an investment property.
The cap rate is the net operating income of a property divided by the total loan amount. Thus, this calculation is similar to the mortgage constant but uses net operating income instead of debt service.
Real estate investors tend to look for properties where the cap rate is higher than the mortgage constant. In the words, the property earns more in a year than the cost of the mortgage.
Bottom Line
Knowing your mortgage constant is an important part of determining whether a property is viable, both for those buying a home for themselves and for real estate investors. For lenders, it can be a useful way to assess the overall risk of extending credit to a borrower. While it is possible to calculate the mortgage constant on your own, there may be tables that have already calculated it for you or you can use a calculator built to help you figure it out quickly.
Mortgage Tips for Buyers
When you’re looking to get a mortgage on a new home, it’s important to understand how much you should put down and what interest you can afford. Because your situation is unique, you may benefit from working with a financial advisor who can help you figure it all out. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Before you consider buying a home, it can be helpful to start with how much home you can afford. Our interactive tool guides you through the process to estimate how much home you can afford based on your unique situation.
SmartAsset’s home buying guide can help answer any remaining questions you might have about buying a home as well as the costs involved.
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