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About Annual Loan Constant
If you are looking to buy a new home, you probably need to know if you can afford the mortgage payment.
There are many parameters that you may need to understand for mortgage affordability.
However, there is one term specific that will help you to understand your annual mortgage expense called “Annual Loan Constant”. In this post, we will understand what is annual loan constant is, how it works and how is it calculated.
What Is Loan Constant?
The definition of loan constant which is also known as mortgage constant is a percentage that shows the annual debt service on a loan in proportion to the whole principal value.
This ratio helps the borrower to compare and choose the loan with the lowest annual mortgage constant saving thousands of dollars on their mortgage payments.
The lowest loan constant means that the borrower will be making less payment on the interest and principal over the period of the loan.
How Does The Annual Loan Constant Work?
In the mortgage constant, the annual debt payments are compared to the entire principal loan amount.
The debt payment on the loan is the total amount that the borrower has to pay including the interest and principal over the set period of the loan.
The principal is the loan amount that you borrow from the bank or the lender, for example, if you borrow $250,000 to buy a home, your principal amount is $250,000.
The interest amount is what the lender charges you for lending you the money to buy the home, for example, if you borrow $250,000 with the interest rate of 6%, your interest amount in the payments would be calculated according to the 6% interest rate on the principal balance.
The loan constant is the percentage that may help the borrower to determine and understand the factors that affect the loan and how much they have to pay every year compared to the loan principal amount.
How Is Annual Loan Constant Calculated?
To calculate the loan constant, the borrower would require a few terms from the lender or the banks that they are borrowing the loan from.
These terms are; interest rate, loan principal, payment frequency, and loan tenure. Once you have these terms from the lender or the bank, you can calculate the annual debt service by multiplying your monthly payments by 12.
After you have your annual debt service, you can use the following formula to calculate the loan constant.
Loan Constant = Annual Debt Service / Total Principal Amount
Let us take an example.
If a borrower takes a mortgage of $250,000 to buy a new property with an interest rate of 5.75% for 30 years.
With the use of our online calculator, you can get the monthly payments for the mortgage which is $1,458.93. Hence the annual debt service would be $1,458.93 x 12, which equals $17,507.16.
Loan Constant = 17507.16/250000
Loan Constant = 7.00%
So in our example, the annual loan constant for the borrower would be 7%. If the same debt is amortized for 25 years the annual mortgage constant for the borrower would be7.5%.
The borrower can use the same formula to calculate the mortgage constant from the quote from different lenders and loan programs and decide which one is best.
More About Annual Loan Constant
After multiplying by the original principal amount of the loan, the mortgage constant gives the dollar amount of the annual debt service. This can be used to compare the actual cost of the loan.
The annual mortgage constants are only available for fixed-rate loans because the annual debt services in variable interest rates have different loan levels every year.
If the borrower is given multiple options of loan, the borrower will go with the one with the lowest loan constant.
Conclusion
Annual loan constant could be one of the best-comparing factors to determine which loan is best for you.
This parameter is also used by real estate investors to understand the cash flow of investment properties.
Get in touch with your trusted real estate agent to get in-depth knowledge about the annual loan constant.
