Certified Residential Appraiser Practice Exam

How is the Mortgage Constant calculated?

1. Loan Amount / Annual Interest Rate

2. Annual Debt Service / Loan Amount

3. Monthly Payment / Loan Amount

4. Annual Rent / Property Value

The correct answer is: Annual Debt Service / Loan Amount

The Mortgage Constant, also known as the loan constant, is calculated by dividing the annual debt service (the total amount of money paid in a year to service the debt) by the loan amount. This provides a percentage that represents the cost of borrowing on a yearly basis, expressed as a fraction of the initial loan amount. By using annual debt service in this calculation, it reflects the total cash flow needed for debt repayment, which is crucial for understanding the true cost of the mortgage over time. This ratio is particularly useful to lenders and investors because it allows them to compare the cost of different financing options regardless of the loan amounts or terms. In contrast, the other options provided do not correctly capture the essence of the Mortgage Constant. The first choice focuses solely on the annual interest rate in relation to the loan amount, which doesn't factor in the actual payments made. The third option also misrepresents the calculation by dividing monthly payments by the loan amount, failing to account for the annual context needed. Lastly, the fourth choice is unrelated, as it compares rent to property value, which pertains more to income capitalization methods rather than mortgage finance.