A repayment loan is a form of credit in which the repayment remains the same throughout the term. However, as interest rates fall from rate to rate, the repayment rate decreases to the same extent. This leads to a heavy financial monthly charge at the beginning of the loan term, which becomes less and less over time. In the past, the repayment loan was considered the standard form of mortgage lending, but today, especially in the case of real estate loans for homeowners, has been almost completely replaced by the annuity loan.
How exactly does a repayment loan work?
The construction of the repayment loan is relatively simple: For example, if a mortgage of 4 percent per year is set for a building loan of more than 150,000 dollars, the borrower will repay 625 dollars each month until the end of the term (7,500 dollars per year). With an assumed interest rate of 2 percent per year, the first repayment rate would be USD 872.74. The last installment of the third year, however, would only be 836.61 dollars. This is due to the fact that interest is only payable on the remaining debt, which decreases every month. At the end of the term, the rates are therefore getting closer to the pure repayment amount of 625 dollars per month.
When does a repayment loan make sense?
A repayment loan is particularly useful if the borrower’s income fluctuates and is currently at a very good level. This can be the case for the self-employed, who can pay off a lot in the beginning and later face a decreasing financial burden. Landlords also sometimes use the repayment loan because they have the rental income to service the high repayments. Today, however, banks hardly offer the repayment loan to private customers.
What are the differences between a repayment loan and an annuity loan?
The biggest difference between a repayment loan and an annuity loan is the constant installment. In the case of a repayment loan with constant repayment, the repayment rate drops every month, since only interest is due on the respective remaining debt. The annuity loan, on the other hand, entails constant repayment rates over the entire term. The falling interest payments are simply offset by a higher repayment to the same extent. Thus, the repayment increases over time without increasing the repayment rate.
Which is better: annuity loan or repayment loan?
The repayment loan has the advantage that the high repayment at the beginning allows the remaining debt and the interest to fall faster. If the repayment is high enough at the beginning, the total effective cost of the financing can also be lower than for the annuity loan. In return, the financial burden is very high at the beginning, which can be a problem for many borrowers. In addition, repayment loans are often issued without the option of free special repayments, which ultimately makes them more inflexible. With the annuity loan, borrowers go a more elegant way because they initially keep the burden within tolerable limits. However, later savings due to falling interest payments are immediately reinvested in a higher repayment.
In connection with the more predictable monthly installment, the annuity loan is in most cases the more interesting option today. If you have a high income, you can also opt for a full repayment loan, in which the entire loan amount is repaid within the first fixed interest rate. In terms of construction, however, such a loan works just like an annuity loan.