The mortgage constant represents:
Correct Answer
C) Annual debt service divided by the original loan amount
The annual mortgage constant is annual principal-and-interest debt service divided by the original principal under the stated level-payment model. It differs from the note coupon and a property capitalization rate. Avoid an absolute comparison to interest for every conceivable amortization or payment structure.
Why This Is the Correct Answer
Option C is correct because the mortgage constant is the ratio of annual debt service to the principal amount of the mortgage loan, expressed as a percentage of the original loan amount. It serves as the capitalization rate for the debt component of a property.
Why the Other Options Are Wrong
Option A: The lender's required equity contribution
Option A calls the mortgage constant the lender's required equity contribution. Equity is the buyer's investment, not a ratio of debt service to loan amount, so this describes a different concept.
Option B: The loan's stated interest rate alone
Option B calls it the loan's stated interest rate alone. For an amortizing loan, debt service includes principal repayment as well as interest, so the constant reflects both and differs from the note rate.
Option D: The property's overall capitalization rate at purchase
Option D calls it the property's overall capitalization rate at purchase. The overall rate relates a property's NOI to its value, while the mortgage constant relates the loan's debt service to the loan amount.
Payment Over Principal
The mortgage constant is annual payment divided by the original loan. It includes principal repayment, so it is not just the interest rate.
How to use: Use this to distinguish the mortgage constant from the interest rate and the overall rate.
Exam Tip
Choose the definition that names annual debt service and the loan amount; the interest rate alone ignores principal repayment.
Common Mistakes to Avoid
- -Treating the mortgage constant as the interest rate
- -Confusing the mortgage constant with the overall capitalization rate
- -Using a monthly payment without annualizing it
Concept Deep Dive
Analysis
This question tests the definition of the mortgage constant. It is the ratio of annual principal and interest debt service to the original loan amount. It differs from the interest rate, from equity requirements and from a property's overall capitalization rate.
Background Knowledge
The mortgage constant, or annual loan constant, captures both interest and principal repayment of an amortizing loan. In the band-of-investment method, it is weighted with the equity dividend rate to develop an overall capitalization rate.
Real-World Application
An appraiser building a band-of-investment rate gathers typical loan-to-value ratios, interest rates and amortization terms from lenders. The appraiser converts those terms into an annual mortgage constant to weight against the equity dividend rate.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
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