The loan constant ratio is a key financial metric used primarily in commercial real estate finance and lending to assess the annual payment burden relative to the original loan amount. It is calculated by dividing the total annual loan payments (including both principal and interest) by the original loan amount and then multiplying by 100 to express it as a percentage.

Understanding the Loan Constant Ratio

The loan constant gives lenders and investors a quick way to compare loan repayment costs regardless of the loan’s interest rate or amortization period. For example, a loan with an annual debt service of $70,000 on a $1,000,000 loan has a loan constant of 7%, meaning 7% of the initial loan balance is repaid each year.

How is it calculated?

The formula is:

Loan Constant Ratio = (Annual Debt Service / Original Loan Amount) × 100

  • Annual Debt Service includes all payments toward principal and interest for the year.
  • Original Loan Amount is the initial sum borrowed.

If you pay $15,000 monthly on a $2,500,000 loan, your annual debt service would be $180,000, and the loan constant ratio would be 7.2%.

Why is the Loan Constant Important?

  • For lenders: It helps assess loan risk and compare repayment structures quickly.
  • For real estate investors: It assists in evaluating if the property’s income covers the debt by comparing with the net operating income (NOI).
  • For analysts and underwriters: It standardizes loan comparisons and aids in loan approval decisions.

Loan Constant vs. Debt Service Coverage Ratio (DSCR)

While both relate to debt, the loan constant measures the loan payment as a portion of the loan amount, whereas DSCR compares property income to the debt payments. Both metrics together give a fuller picture of loan and investment viability.

Tips to Remember

  • The loan constant includes principal and interest, so it’s typically higher than the loan’s interest rate alone.
  • The amortization period directly affects the loan constant — shorter terms increase it.
  • Understanding this ratio helps in comparing loans and projecting loan costs effectively.

For more on related concepts, see our articles on Commercial Real Estate Loan and Debt Coverage Ratio.

External Reference

For authoritative details on loan amortization and calculations, visit the Investopedia Loan Constant Definition.