What Is a Mortgage Constant?
In a typical mortgage, the lender loans out the total amount borrowed, known as the principal. This amount, often minus any down payment made by the borrower, is combined with an interest rate. Interest accumulates daily and is added to every monthly payment that borrower must make. The borrower pays off both principal and interest with each payment, gradually reducing the principal and so reducing how much interest the applied rate creates, until the principal is fully paid off. A mortgage constant is a calculation that shows payments in relation to the total mortgage.
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Definition
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A mortgage constant is a financial tool that shows how one year's payment compares to the total amount of the mortgage. In this case, the total amount of the mortgage includes the interest that is paid. Since payments are typically made monthly, the constant is found by combining these monthly payments together into an annual payment and making that payment a percentage of the total loan.
Debt Calculations
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The mortgage constant is often used in debt calculations that lenders make when judging the solvency of potential borrowers. A lender does not want a borrower to have too much debt compared to both monthly and annual income. A debt-to-income ratio will show all the liabilities a borrower has in relation to how much income the borrower currently makes. Lenders look for low rates, often no more than 10 to 20 percent. The mortgage constant helps them analyze the borrower's financial situation in terms of the loan she is applying for.
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Investment
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The mortgage constant is also often used in mortgage investment. Lenders make a business out of selling mortgages to other organizations and investors, but they do not always sell the mortgage immediately. This means that mortgages can be traded when they are only partially paid off, but investors prefer a way of telling how much of the mortgage is left and what type of payments are expected on it. The mortgage constant gives them an easy way to express where the loan is in terms of annual payments, and so how much it is currently worth.
Interest Rates
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The mortgage constant is affected by interest rates, but neutralizes them as part of its calculation. The amount that the borrower actually pays in a total year will always be more than the percentage the mortgage payment indicates, because the borrower is also paying interest. This is especially true of variable rate mortgages, where annual payments will vary but the percentage of the principal paid off will remain the same.
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