Mortgage Constant

The mortgage constant is a year of loan payments, principal and interest, divided by the loan balance. At 7.25% over 30 years it is about 8.2%. It is the debt-side input to the band-of-investment cap rate derivation and the number to compare against a cap rate to see whether borrowing helps.

The constant runs above the interest rate on an amortizing loan because it includes principal. At 5% over 30 years it is about 6.4%; at 6% about 7.2%; at 7% about 8.0%. Interest-only loans have a constant equal to the rate.

When the cap rate exceeds the mortgage constant, every borrowed dollar earns more than it costs and the leveraged return rises above the cap rate. When the cap rate is below the constant, leverage is negative. This is also why DSCR clears or fails: a property whose cap rate sits above the constant covers its debt service with margin, and one below it does not. In the band-of-investment method, the cap rate is the LTV-weighted blend of the mortgage constant and the equity investor's required return.

Further reading: Mortgage Constant on Wikipedia.