What Are Annuity Payments

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What Are Annuity Payments
What Are Annuity Payments

Video: What Are Annuity Payments

Video: What Are Annuity Payments
Video: Understanding Annuity Basics – How Do Annuities Work? 2024, March
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The boom in consumer and mortgage lending is forcing borrowers to master the alphabet of financial calculations. Everyone understands that lending by banks, both to enterprises and individuals, is not charity at all. Therefore, it is important for borrowers to reduce the burden by reducing the amount of interest payments. But the most often used annuity payment method is more profitable for banks.

What are annuity payments
What are annuity payments

Loan repayment schemes

There are two schemes of loan repayment - differentiated and annuity monthly payments. They differ in the amount of payments. With differentiated repayment, you pay different amounts every month, at the beginning these amounts are higher, towards the end of the maturity they become lower. Annuity payments are always paid in the same amount.

The calculation of the differentiated payment is simple - the total loan amount is divided by the number of months - the loan term, and monthly interest on the loan balance is added to these payments to repay the loan amount. The longer you pay off the loan, the less the remainder of your debt becomes, the less interest is charged on it.

The formula for calculating the monthly annuity payment is more complicated. Under this scheme, interest is also charged on the balance of the debt, but the principal is not paid in equal installments. It turns out that at the beginning of the loan term, the amount of the monthly payment is mostly interest, in a smaller part - payments on the principal debt. The ratio between them changes every month towards an increase in the amount of the principal debt, but the total monthly paid amount remains unchanged.

Pros and cons of annuity payments

According to this scheme, it turns out that the borrower pays the bank interest in advance, i.e. the bank first withdraws its income from the amount of monthly payments, and then this amount is already sent to pay off the principal debt. An annuity loan repayment scheme is more profitable for a bank than a differentiated one. This method is especially disadvantageous for you if you want to repay the loan ahead of schedule, in which case the actual interest will turn out to be much higher than that specified in your loan agreement. In addition, some banks may refuse to recalculate the monthly paid amount in the event of a partial early repayment.

The advantages of the annuity loan repayment scheme for the borrower include the convenience of calculation - you know exactly how much money you spend on this monthly and it is much easier for you to control the repayment process. Since the first payments for differentiated loan repayment can be quite significant amounts, not all borrowers will be able to separate them from their monthly income. But inflationary processes are also an objective reality, so annuity payments are more profitable for long-term lending, if, for example, you take money in a mortgage for a period of 10 or more years.

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