Why a Lower Interest Rate Loan May Not Be the Best Option
When shopping for a commercial real estate loan, most investors fixate on the usual metrics: interest rate, term, amortization, and prepayment penalties. And sure, a lower interest rate sounds like the obvious winner. But in today’s market, there’s a lesser-known factor that could impact your cash flow just as much—if not more.
Enter the Loan Constant: The Overlooked Metric
The loan constant is the ratio of annual debt service to the total loan amount. Unlike the interest rate alone, this metric gives you a real picture of your financing costs.
With rising interest rates, many lenders are getting creative, offering extended interest-only periods to keep loan constants in line with previous low-rate environments.
Let’s Break It Down
The loan constant is calculated using two primary variables:
Annual Debt Service – The total amount paid toward the loan each year, including both principal and interest.
Total Loan Amount – The original loan principal borrowed.
Loan Constant Formula:
It is typically expressed as a percentage.
Key Factors Affecting the Loan Constant:
Interest Rate: Affects the total debt service cost.
Loan Term (Amortization Period): A longer amortization period lowers annual debt service, reducing the loan constant. Typically 20-35 years
Loan Type:
Fully Amortizing Loan: Includes both principal and interest, leading to a higher loan constant.
Interest-Only Loan: Only interest is paid during the term, lowering the loan constant.
OK, BUT REALLY.
A few years ago:
📌 4.5% interest rate, 25-year amortization → Loan Constant: 6.67%
Today’s market:
📌 6.5% full-term interest-only loan → Loan Constant: 6.50%
Surprising, right? Even with a higher interest rate, the cash flow situation may actually improve thanks to interest-only structures. This is why investors refinancing out of those ultra-low-rate loans from the past few years shouldn’t panic—a higher rate today doesn't always mean worse cash flow.
What This Means for You
If you’re in the market for a refinance or new loan, don’t just chase the lowest rate—focus on the loan constant and your actual cash flow. Want to see how this plays out for your portfolio? Let’s crunch the numbers together.
