What is a Loan Constant?
Loan Constant is a financial term, somewhat related to Cap Rates and Cash on Cash, in that it indicates on a percentage basis the cash return to the lender relative to the outstanding loan balance. Constant basically tells us how much principle and interest is being paid back to the lender divided by the loan amount.
Let's take a look at the formula and I'll run through a couple examples.
Loan Constant or K, as it's abbreviated, is simply the annual debt service divided by the loan balance. Imagine we have a $1,000,000 loan at, say, 6% per year amortized over 30 years. In this case, our annual debt service would be approximately $72,000 a year. Divided by a million dollars, that comes to a constant of 7.2%.
If that same loan were amortized over just 25 years, our annual debt service would be about $77,000 or a 7.7% constant. Of course, if the interest rate went up to, say, 7% over 25 years, then our debt service would be in the $84,000 range or an 8.4% constant.
Lender's return, cash-on-cash return to the lender, changes depending on the terms of the loan that is written. Lenders that want to recoup cash more quickly can charge 100% interest rate or shorten their amortization in order to do so.
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