If you borrow money, the loan can be repaid in two ways, namely with annuity (which is common for all sms loans) or with straight amortization. Even when you want to apply for a sms loan without UC, the repayment is often done through annuity. There is a difference between the alternatives when it comes to how the monthly payments are divided between interest and amortization and the characteristics of annuity loans are:
- You pay the same amount every month for the entire repayment period
- The percentage of interest decreases and the amortization increases every month
An annuity loan will be slightly more expensive than straight amortization. However, there will be no greater extra cost and for many, the extra interest cost is a cheap money to pay in order to partly avoid more onerous first months of the maturity, and partly to get an exact information on what is to be paid each month.
Explanation of annuity loans
The word annuity comes from the French and means annual payment . Today, however, the word is used for all possible payback periods. When you select annuity as the calculation model for a loan, as mentioned earlier, you will be able to pay exactly the same amount for each payment period, such as one month. Is your first monthly payment of $2000 is also the last of exactly the same amount.
What the fixed amount means is that the interest rate portion will be greatest at the beginning of the loan period and then gradually decrease. If the interest rate is of the slightly higher model, the first monthly payments may actually consist almost entirely of interest. On the last payment, the interest portion, on the other hand, is basically non-existent in comparison with the amortization.
What is straight amortization?
In this context, it may be good to have a shorter review of how straight amortization works. With straight amortization, the amount of the amortization is the same for the entire term and the interest cost, which of course decreases in size the more of the loan amount that is amortized, is added to the total monthly cost. The monthly payments will be greatest at the beginning of the term and then gradually decrease.
What happens when interest rates change
If the interest rate on the loan changes, up or down, one of two things happens, namely:
The repayment period changes (false annuity)
The monthly payment will be lower / higher but the repayment period will remain the same (genuine annuity).
Most commonly, the lender uses the calculation model for false annuity, but it is not uncommon for genuine annuity. What applies in the individual case must be stated in the loan terms.
On all loans you can always make extra payments at any time. What then happens to the annuity loan if parts of it are paid off in advance? Well, normally you have to choose if you want to lower the monthly cost or shorten the repayment period. What is the best option is really a matter of taste. Most people usually choose to shorten the repayment period in order to become debt free faster.
Which option is best?
There is no clear answer to which option is best. It all depends on your preferences as a borrower. If the borrower has a very strong economy, a straight repayment can be advantageous because then you start paying off a large part of the loan directly. At each installment, the interest rate becomes smaller while the loan repayment is the same. This means that the installment is generally reduced for each month. An annuity loan may be preferable for those with a slightly weaker financial position. With an annuity loan, you can pay a little less in the beginning compared to a straight amortization. However, the total installment amount is the same all the time. This is because the first payments are largely made up of interest payments, while the loan repayments are not very large. What is best is up to the borrower himself to decide.