how a loan constant works
a loan constant is a comparison of a loan s annual debt service to the loan s total principal value a loan s debt service is the total cash the borrower must pay to cover the repayment of interest and principal on the loan for a given period the loan constant is expressed as a percentage and can be determined for all types of loans it helps borrowers and analysts to understand better the factors involved with a loan and how much they are paying annually in comparison to the loan principal a mortgage constant is a loan constant that is specific to a real estate loan calculating a loan constantcalculating the loan constant often requires a borrower to obtain from the lender the multiple terms associated with the lending deal terms include factors such as total principal loan interest rate length of payments and frequency of payments obtaining these loan term factors allows for the calculation of a simple present value payment to arrive at the monthly payments once the monthly payments are identified a borrower can easily calculate their loan constant using the following equation loan constant annual debt service total loan amountfor example take a mortgage borrower who has obtained a 150 000 loan the loan has a fixed interest rate of 6 with a 30 year duration and monthly interest payments using a payments calculator the borrower would calculate monthly payments of 899 33 which results in an annual debt service of 10 791 96 with this annual debt service the borrower s loan constant would be 7 2 or 10 791 96 150 000 special considerationsthe loan constant when multiplied by the original loan principal gives the dollar amount of the annual periodic payments the loan constant can be used to compare the true cost of borrowing loan constants are only available for loans with fixed interest rates since variable interest rates have differing annual debt service levels based on variable interest given the choice of two loans a borrower will generally opt for the one with the lower loan constant since it will have the lower debt service requirement loan constant tablesloan constant tables were widely used in the real estate industry before the advent of financial calculators since they made it relatively easy to calculate monthly mortgage payments loan constant tables provide prepopulated information for borrowers about their loan with a quoted loan constant level if the borrower from the example above were given their loan constant they could find the interest and payment terms from a loan constant table without other inputs the borrower would only need to identify 7 2 in the table from there they would find the corresponding interest rate of 6 on the horizontal axis on the vertical axis the number of payments in months would also be provided at 360 the concept of loan constant is especially relevant in the area of commercial real estate since when compared to the capitalization rate an investor can tell if they will actually make or lose money on the part of the investment they finance for example if an investor is buying an apartment building with a 7 cap rate and their loan constant is 6 then they will be earning 1 on the borrowed money and 7 on equity however if the loan constant is 7 1 2 then the investor would be losing 1 2 of 1 on the mortgaged part of the investment 