Taking out an annuity loan is easy without security but also the most common type of personal loan. Annuity loans work by equalizing the cost of interest and amortization for you and distributing them in a way that allows a fixed amount, the so-called annuity amount.
What are the annuity loans?
According to Moni365, his means that you as a borrower must always repay the same amount of money, a constant amount (annuity), every month until the loan is fully repaid. If you take out an annuity loan, it simply means that you repay a certain amount of money each month. This amount includes both the interest cost of the loan and the repayment amount of the loan, ie the repayment amount.
This means that you will pay a high part of the interest cost and a slightly smaller part is the amortization amount. When the loan amount decreases, the interest cost will also be lower, which means that you will repay an increasing amount. With an annuity loan, you pay off the loan slowly at the beginning and then repay an increasing amount at a higher rate and thus reduce the loan amount itself more quickly. The term of an annuity loan is always set at a certain number of years.
Annuity loan – Simple monthly payment in two parts
When your loan is repaid, your monthly payment consists of two parts. These two parts are the interest cost and the repayment of the debt, the so-called amortization. The interest cost is the remaining debt multiplied by the interest rate (the interest rate), which means that the more you pay off your loan, the lower the interest rate and the interest cost decreases as you pay off your loan. The interest cost is thus the most expensive at the beginning of the loan term and becomes cheaper over time.
Loans with straight amortization or annuity, what is best for you?
If you choose straight amortization on your loan instead , it has its advantages and disadvantages. The biggest advantage of a simple annuity loan is that you know exactly how much you will pay back each month. The downside may be that the total cost of your loan gets higher each month. If you choose straight repayment on your loan instead, the total cost of the loan will be lower , but it will be a more expensive monthly cost. This is because the debt decreases faster as you repay the same amount from day one. For you, it is then important to check that it is in your budget to pay more in the beginning.
The interest rate changes or the interest rate rises, how are you affected?
The interest rate can change and will go up and down during your loan period . If you choose an annuity loan, the monthly cost should be the same, but how does it go together with changed interest costs? Below are two different options.
- False annuity or retained annuity – you keep the same monthly cost
- Retained annuity means that the same monthly cost will apply, even if the interest rate changes. It can instead mean that the loan period is extended or shortened to then compensate for a change in interest rates. Maintaining an annuity, ie paying the same cost every month, is a security for you.
- True annuity or changed annuity – Your monthly cost is adjusted according to the interest rate
Here, the bank instead makes a new calculation of what or how much you should pay a so-called changed annuity, to adjust the higher interest rate paid each month. The same loan period applies here, but there is a chance that the monthly amount will be increased in line with the repayment period if the interest rate does so. When you choose a changed annuity, the loan will thus be repaid on the date that was said when the agreement was written, but can thus become more expensive each month during the time if the interest rate is raised.
A third but more unusual form of amortization is called series amortization. Here you gradually increase your amortization during the repayment period. This is often planned per year and then you choose, for example, to repay 5 percent of the debt during year one, 10 percent during year two and so on. This can be suitable if you want to adjust your amortization according to the expected increase in income. This form of amortization is very unusual in Europe today.
Benefits of annuity loans
One of the many benefits of an annuity loan is that you avoid excessive increases in your monthly cost. So you know in advance how much you will have to pay in each month. The monthly cost here is constantly the same, unlike other loans where your monthly cost can vary greatly. It will then be easy for you to plan your personal finances. It is therefore an advantage for you to have a loan with a maintained annuity with a good interest rate.
- When should you choose an annuity loan?
- When you want the same monthly payment every month
- When you have less ability to pay at the beginning of the loan period and higher at the end
- When a steady monthly payment is more important to you than the total cost of the loan
- When should you choose straight amortization?
- When you want to get rid of your loan as soon as possible
- When you want to reduce your monthly cost gradually
- When your ability to pay at the beginning of the loan period is high
What is a good interest rate on a personal loan?
A good interest rate is of course a low interest rate that stays low throughout your repayment period and lowers the total amount to pay. However, the interest rate is characterized by several different factors and there is no clear path that leads to a perfectly effective interest rate, but you will find the best interest rate on your private loan by comparing as many offers with lenders as possible and see what works best for you.
Be sure to think about the banks’ standard fee for their services per month, as well as what their terms are for your loan in the form of interest rate and repayment period when you compare loans and interest rates.
Experiment with comparing the effective interest rate and how it is affected by when you change the time when you intend to repay the loan, and whether a fixed or a variable interest rate is better suited for the given period. You should also gather information about what the fixed income market looks like at the moment when you want to borrow your private loan, whether inflation is at a low or high level and how your loan would be affected if you were to pay fixed or variable interest.
When it comes to interest, it is also important to know about interest deductions or tax reductions, as it can also be called, which means that you can make a deduction in your tax return for the interest you pay for the loan, so that the final amount is less and therefore also the loan will be more favorable for you. Most often, however, banks have already deducted the tax deduction from their interest, so it is important to pay attention to the issue and check what applies to each bank and each loan.