Mortgage Constant

The mortgage constant takes one year of principal and interest payments and divides it by the loan balance. For 7.25% over 30 years, it comes to 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.

On an amortizing loan the constant sits above the interest rate, since principal is part of the payment. 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.

Once the cap rate is higher than the mortgage constant, each borrowed dollar earns more than it costs, lifting the leveraged return above the cap rate. If the cap rate sits under the constant, the 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.

To calculate the mortgage constant, take one month of principal and interest, multiply it by 12, then divide by the loan balance. A $375,000 loan at 7.25% over 30 years pays about $2,559 a month, or $30,704 a year, which is 8.19% of the balance.

Only the rate, term and amortization change the answer, not the loan size: the same 7.25% 30-year terms give an 8.19% constant on a $100,000 loan and on a $1,000,000 one. On a $500,000 property bought with 25% down, that $375,000 loan means the cap rate has to clear about 8.2% before each borrowed dollar adds to the return.