## What is an Annuity Loan?

The classic loan form for loans and real estate loans is the annuity loan. With this type of financing, you repay the loan amount over the entire term in constant installments. This means that you always pay back the same high loan rate to the bank every year. The installment can be paid in monthly, quarterly or semi-annual installments, depending on the agreement. However, monthly installment payments are the most common payment model for annuity loans.

## Why does an annuity loan make sense?

The annuity loan offers you as a borrower a secure basis to be able to use the financing loan securely over the entire term. Because of the consistently high repayment rates, you can calculate your monthly budget very precisely over years or even decades. For example, if you contractually agree a twenty-year fixed interest rate with your bank, you always pay the same annuity. In plain language: From the start of financing until the end of the interest period, you pay the same monthly rate.

### How does an annuity loan work?

The annuity loan rate is made up of an interest component and a repayment component. At the beginning of the fixed interest period, the interest component predominates, because at this point in your financing you still pay interest on the full remaining debt. The remainder of the installment is used to repay the loan. So you start reducing your loan debt from day one.

The special thing about annuity loans is that the interest component is recalculated at every rate from the outstanding debt. So you only ever pay interest on the remaining debt. And since the residual debt is reduced by the repayment portion at every installment paid, the interest portion also decreases steadily from the start.

At the end of the term, the repayment component will predominate so much that your monthly installment will almost exclusively pay into the repayment of the loan.

## Calculate annuity loans: This is how the ratio of interest and principal payments changes

The following calculation example shows how strongly the ratio of interest and repayment costs changes over the course of an interest period: Suppose you take out a loan of $ 200,000, which bears interest at 1.34% and is repaid at 3%. The fixed interest rate is fixed at 10 years. This calculation results in an annual annuity of $ 8,680. If you calculate the annuity over 10 years, the ratio of interest and repayment costs changes as follows:

year | Annuity (annual rate) | Interest costs | Repayment costs | Remaining debt |
---|---|---|---|---|

1 | $ 8,680 | $ 2,643 | $ 6,037 | $ 193,963 |

2nd | $ 8,680 | $ 2,562 | $ 6,118 | $ 187,845 |

3rd | $ 8,680 | $ 2,479 | $ 6,201 | $ 181,644 |

4th | $ 8,680 | $ 2,396 | $ 6,284 | $ 175,359 |

5 | $ 8,680 | $ 2,311 | $ 6,369 | $ 168,990 |

6 | $ 8,680 | $ 2,225 | $ 6,455 | $ 162,535 |

7 | $ 8,680 | $ 2,138 | $ 6,542 | $ 155,993 |

8th | $ 8,680 | $ 2,050 | $ 6,630 | $ 149,363 |

9 | $ 8,680 | $ 1,960 | $ 6,720 | $ 142,643 |

10th | $ 8,680 | $ 1,870 | $ 6,810 | $ 135,833 |

## Advantages and disadvantages of annuity loan

- High degree of planning security: The annuity loan offers a high level of planning security because the rate remains constant during the fixed interest rate.
- Repayment from the beginning: The repayment of the remaining debt begins with the first installment. Although the repayment portion is small at the beginning, it increases continuously in the course of the financing.
- With each installment, the repayment increases: The interest component is calculated again and again at each installment from the outstanding debt. As the remaining debt is reduced at every rate, the repayment portion also increases automatically.

- No flexibility: During the fixed interest period, repayment of the loan is generally not possible without payment of a prepayment penalty.
- Interest rate risk: It is difficult to predict how interest rates will develop. Therefore, there is always the risk that the interest level will be higher when the fixed interest rate expires and that follow-up financing will have to be concluded on poorer terms.

### Why is the repayment rate so important?

The goal of any mortgage lending should be to repay the loan to the bank as soon as possible. Because the faster you repay the loan, the less interest costs are incurred over the entire term of the loan. Banks usually require a redemption of at least 1%. Comparison.de recommends you to agree at least 2, better 3% repayment at a low interest rate.

A simple calculation shows how the amount of the repayment affects the duration of the financing. Let’s say you borrow from a bank $ 200,000, the borrowing rate is 2.8%. The loan is fixed for 10 years:

Repayment rate | Monthly Rate | Interest costs | Total time of the loan |
---|---|---|---|

1 % | $ 633 | $ 52,950 | 35 years and 11 months |

2% | $ 800 | $ 49,900 | 26 years and 5 months |

If you repay the loan with 1%, a monthly payment of $ 633 is due. If you paid off the loan in full at a new borrowing rate after the end of the borrowing rate of 6.50%, you would be debt free in 35 years and 11 months. On the other hand, if you agree to a repayment of 2%, you pay a monthly installment of $ 800 per month, but you will have finished repaying the loan in 26 years and 5 months. With a 2% repayment, you paid off your loan 9 years and 6 months faster and also saved $ 3,050 in interest costs during the ten-year fixed interest rate.

## Use the annuity calculator to calculate the annuity loan

Our annuity calculator calculates how the term and costs behave at different repayment rates. The calculator provides you with a detailed repayment schedule for your annuity loan based on your data. Instead of the annual annuity, the annuity calculator calculates the monthly loan installments.

The advantage: You can immediately compare the costs with your monthly income and quickly find out what the maximum loan amount can be. The calculation of the annual annuity, however, mainly serves the bank for the internal settlement of your loan.

## How long can I take out an annuity loan?

As a rule, the borrowing rate for the annuity loan of a building loan is fixed for 5 to 15 years. The annuity loan of a classic installment loan, on the other hand, is offered with terms of 12 to 120 months. The interest rate remains constant during the borrowing period. Regardless of the fixed interest rate, you can make use of your special right of termination for a building loan after 10 years and redeem the annuity loan with a notice period of 6 months without having to pay a prepayment penalty.

### After the fixed interest period has expired, there is an interest rate risk

When deciding how long you want to secure the current interest rate level, you should always include the interest rate risk in the calculation. Even if an annuity loan with a short term is offered at particularly favorable interest rates, there is a risk that the interest level will be higher at the end of the fixed rate period.

If this is the case and you have not fully repaid your loan by then, you will have to take out more expensive follow-up financing for the remaining debt. Therefore, the following applies: Secure a low interest rate for a long period of 15 years or more. How to protect yourself from rising interest rates for longer.

## Secure favorable interest for follow-up financing

In order not to take any interest rate risk when it comes to follow-up financing, you can secure a favorable interest rate level in advance with a forward loan. However, the best way to keep the interest rate risk on follow-up financing as low as possible is still a high repayment. Because the lower the residual debt at the end of the fixed interest rate, the cheaper the follow-up financing will be.

### Reduce costs further with special payments

With most banks it is possible to have special agreements in the contract; such as the option for special repayments. Special repayments are additional repayments that are made in addition to the regular annuity rate. This will help you to repay the loan faster. If, for example, you receive unexpected cash receipts during the fixed interest period, for example through an inheritance, you can use the special repayment to invest the funds in the repayment of the loan.

In this way you reduce the remaining debt and thereby lower the interest portion. However, banks usually charge an interest premium for the special repayment option. So you should calculate exactly whether this special arrangement pays off for your financing. As a rule, the banks themselves determine the dates and amounts of the special repayments.

## Common mistakes when comparing annuity loans

If borrowers compare annuity loans with each other, they often make a big mistake: they are based on the low borrowing rate and not on the effective rate. For both the construction loan and the installment loan, the effective interest rate includes the total annual costs of the annuity loan, which result from the term, interest payments and settlement dates. The current effective interest rate for real estate financing can be found in our construction money comparison and for classic loans in our loan comparison.