## Table of contents:

- What is an Annuity Loan?
- How does the annuity loan work?
- Formula for calculating the annuity loan
- The best time to take out an annuity loan
- What do you need to consider when completing the degree?
- Differences between annuity loans and home loan loans

## Video: Annuity loans: advantages and disadvantages

If you are looking for the perfect mortgage, you quickly come across the word annuity loan. But what exactly is that? How does it work? And why should you take it on right now? We have the answers.

Table of Contents Table of Contents Annuity Loans: Planning Security Despite Flexibility

- What is an Annuity Loan?
- How does the annuity loan work?
- Formula for calculating the annuity loan
- The best time to take out an annuity loan
- What do you need to consider when completing the degree?
- Differences between annuity loans and home loan loans

Table of Contents Table of Contents Annuity Loans: Planning Security Despite Flexibility

- What is an Annuity Loan?
- How does the annuity loan work?
- Formula for calculating the annuity loan
- The best time to take out an annuity loan
- What do you need to consider when completing the degree?
- Differences between annuity loans and home loan loans

## What is an Annuity Loan?

The definition of annuity loans is made up of annuity and loans and is therefore as follows: A repayment loan to be repaid in constant installments or constant annual payments. This in turn means that you take out a loan, set a so-called fixed interest period for the entire term - or even just a few years of it - and then always pay the same amount of money for the agreed period from the first to the last installment. This sum is calculated from the interest and the redemption portion. You therefore pay off part of the loan and the interest on it at every installment. At the end of the contract term of the annuity loan, the loan is paid off. Hence the name repayment loan.

But there is also a second variant. This is called a fake annuity loan or installment loan. The borrower has a variable annuity. This means that the repayment component remains the same at every repayment rate, while the interest component continues to decrease. The sum of the installment to be paid is therefore reduced each time.

## How does the annuity loan work?

In Germany, over 70 percent of private construction and property purchase financing is based on a real annuity loan. Constant rates offer planning security to the borrower. The previously mentioned possibility of fixing the fixed interest period to five, ten, 15, 20, 25 or 30 years in the contract goes hand in hand with the possibility to terminate the loan after this period and to negotiate a new, maybe even better interest rate. That allows a certain flexibility. The combination appeals to home builders or home buyers and makes the annuity loan a successful model in Germany.

A variable interest rate can also be agreed in the loan agreement, which is adjusted annually to the market situation. This is more common in southern countries. Whether you pay the annuity loan rate monthly, semi-annually or annually depends on how you have stayed with the bank and can be handled very individually from borrower to borrower.

### Advantages of the Annuity Loan

- Constant rate and very high planning security.
- Repayment plan shows the status of the interest and repayment rates for the entire agreed period of fixed interest rates.
- Possibility to negotiate a better interest rate later.
- The form of the loan is very transparent because the additional costs of the loan must also be stated.

### Disadvantages of the annuity loan

- Long contractual relationship, little to not flexible.
- Possible entry of the loan at Schufa.
- Possibility of finding a lower interest rate later.

Although an annuity loan creates a long contractual commitment, the constant rates offer the borrower planning security.

Photo: iStock / cyano66

## Formula for calculating the annuity loan

Note that if you set the repayment rates, you always pay the same amount for an annuity loan, but this is made up of different numbers each time: The interest portion increases from rate to rate, from payment to payment, less - while the Repayment portion, i.e. the repayment rate, increased every time. Ideally, you will repay one percent of the loan amount in the first year. And then, last year, 100 percent of the remaining credit balance. Because: The regular payment of the loan taken shrinks its amount. Interest is always calculated from the same percentage, but is always applied to the new, shrunk total, which means that the total is reduced each time. With the fixed repayment rate, you pay off less of the interest portion and more of the credit portion on the subsequent payment. This then results in less interest for the subsequent payment, which then benefits the repayment of the loan.

This formula shows you how the annuity, i.e. the amount of the annual payment, is calculated:

Loan amount * interest rate (1 + interest rate) ^ term

_______________________________________________

(1 + interest rate) term - 1

With a loan amount of EUR 100, 000, an interest rate of two percent and a term of five years, the calculation looks like this:

100, 000 * (1.02) ^ 5 x 0.02

_____________________________ = 21, 215.84 euros

(1.02) ^ 5 - 1

If you want to find out your monthly installment amount, this formula can be more practical:

Monthly installment = (loan amount * (interest rate + repayment rate) / 100) / 12

With a loan amount of EUR 100, 000, an interest rate of two and a repayment rate of three percent, the following calculation results:

So you pay monthly: (100, 000 * (2 + 3) / 100) / 12 = 416.66 euros

You can find reliable and good annuity calculators with which you can go on an exploration tour with many calculation examples before your bank call for the annuity loan.

Example: 100, 000 euro loan, the interest rate is two percent, you set the repayment rate to four percent. That makes a monthly charge of 500 euros and after 20 years you have repaid your loan. If you can only afford half, i.e. 250 euros, per month, then you will pay for 55 years. With a repayment rate of eight percent, on the other hand, you are ready after eleven years. Pay more than 830 euros per month.

With an annuity loan, the repayment rates always remain constant. However, since the repayment component increases steadily, the interest component decreases at every rate.

Photo: iStock / Tinnakorn Jorruang

## The best time to take out an annuity loan

But how exactly does the interest rate influence this annuity - what happens if a small number changes? So when is a favorable and when is an unfavorable time to take out an annuity loan? If interest rates are low, you should strike. Just like now. Because: With the low interest rate, you can increase the repayment rate. The money that you would otherwise have paid for the interest can be included in the repayment rate and then you can pay off faster - so you are debt-free more quickly. Don't be tempted to borrow more money than you really need. Because that would negate the positive effect of low interest rates and faster repayments.

## What do you need to consider when completing the degree?

Set up the annuity loan repayment schedule as close to reality as possible: when making the repayment rate and repayment rate, it is very important that you be honest with yourself and the bank advisor. How much house can you afford? How much equity do you have? Because that can negatively affect the amount of the interest rate. The more equity you bring, the lower the interest rate.

Also think about your future. Would you like to have children? Are you self-employed - maybe even in a crisis-prone industry? Do you need a new car in the next few years? In short: What other investments are in the coming years?

Second important point: what is the current situation on the real estate market? Will prices go up or down, will loan rates go up or down? Because if you can hope for falling interest rates, you should set the fixed interest rate as short as possible. If, on the other hand, interest rates are likely to rise sooner, then you should agree to fixed interest rates for a longer period. All of these things should be considered in your considerations. Also make sure that you can suspend a repayment rate in an emergency and that your home won't be taken away if you are behind schedule. And you should also state the opposite: the right to a special repayment each year. This is usually a maximum of five percent of the loan amount.

## Differences between annuity loans and home loan loans

With an annuity loan, you use the installments to pay off both the loan itself and the interest on it. And you have a fixed monthly, semi-annual or annual amount that you pay until the loan amount and the interest accrued are repaid. The home loan, on the other hand, is a so-called interest loan. You can only take advantage of this loan if you have concluded a building society contract - because you use this building society contract to pay off the loan amount.

Sabrina Deckert