This guide covers loan repayment and related concepts. First, we will look at different loan repayment methods, and then introduce the different types of loan repayment approaches. These attitudes can help you reduce your credit.
There are three common ways to repay your loans: annuity loan, lump sum loan, and short term loan. The terms are very similar and the repayment terms seem to be the same at a glance, which makes it very easy to mix loans. Therefore, we will now go over the definitions of the terms, with the help of examples. We start by telling you about an annuity loan, which often comes with mortgages.
Annuity loan, the loan is repaid in equal installments
In an annuity loan, the loan is repaid in equal installments, which include both the principal repayment and interest charges. If the reference interest rate of the loan changes during the loan period, the amount of the installment will also change. However, the term of the loan remains unchanged on the annuity loan. The term annuity refers to an annual installment, but annuity loans can also be repaid monthly, for example.
For example, if the interest rate reference is for a loan is 12-month Good Finance, the interest rate will be adjusted once a year. If the reference rate changes, the annuity loan will be repaid new installments for the remaining term of the loan. In addition to the principal, the new installment comprises interest charges for the remaining period of the loan.
At the beginning of the loan period, the loan amount is at its highest, which is why interest expenses are also the highest. As a result, the monthly installment initially consists largely of interest expenses. At the end of the loan period, the interest rate is relatively low and repayment will accelerate towards the end.
Fixed installment loan
As the name implies, the fixed lump sum loan is always repaid in equal installments regardless of changes in the reference rate. If the reference rate changes, the loan period changes. The installments thus include interest expenses.
If the interest rate changes, the loan period changes.
A fixed installment loan is a variation of an annuity loan. Here, the change in interest rates is reflected in the change in the duration of the loan and not in the rise or fall of monthly installments.
In a repayment loan, the loan amount is repaid in equal installments, but the amount of the payment always varies with the interest rate. The difference with annuity loans is that the interest is always recalculated on the outstanding loan capital. The amount of the installment will thus vary with each installment, even if the reference rate remains the same.
Unlike an annuity loan, the amount of money that comes out of your account in a flat-rate loan is always the same for each installment. If interest rates rise, the monthly installment will also rise.
Which repayment method is most profitable?
Annuity is often not the most affordable way of paying off a loan, because at the beginning of the repayment, most of the installment is just interest payments, and the loan is almost non-repayable.
An annuity loan will thus be more expensive than a flat-rate loan, where interest payments will decrease after each loan installment. In an annuity loan, the interest rate remains the same for each installment, since the interest cost is calculated on the full amount of the loan at the very beginning of the loan period.
In the case of consumer loans, the reference interest rate is fixed and is exactly the same as the one used for repayment. The installments are the same throughout the loan repayment period and the interest rate decreases as the main loan decreases.