Types of loan payments: differentiated and annuity

What is an annuity payment

To understand which method of repaying a loan is the most acceptable, you first need to understand what an annuity payment is. Its main difference is the ease of loan repayment. In this case, there is no need to clarify the payment amounts each time; the loan body and interest are repaid in equal installments throughout the duration of the agreement. The monthly payment consists of the amount of repayment of the loan body, that is, repayment of the principal debt, and interest that is accrued for the use of loan funds.

With any payment method, one of the main factors of a loan is a small rate. We have looked at for you how to get a loan for pensioners with a low interest rate.

Of the monthly debt repayment amount, the largest part of the payment is the payment of interest, and the smaller part is the amount of the loan outstanding. In this case, in the first months of debt repayment, the loan body is practically not repaid; the main payments come from interest. Loan payments are not large, so interest on the use of credit funds increases.

What is an annuity type of payment?

Annuity payments are equal, most often monthly, payments that the borrower makes at equal intervals. The borrower pays the same amount from month to month, no matter how long ago he repays the loan. Let's return to the example we discussed. If then the payment was annuity, and not differentiated, then you would pay 14,347 rubles in the first, second, third months, up to the 120th. This is undoubtedly more convenient, but isn’t a differentiated scheme more rational? The convenience of annuity payments is obvious. You remember the amount and plan for this expense when allocating your budget.

You will say that it is morally easier to repay the loan in differentiated payments, because the amount of payments decreases from month to month. But, you see, if you take into account inflation and rising wages, over time, annuity payments will become less and less burdensome.

An annuity scheme will cost you more; under a differentiated scheme, the overpayment is lower, so banks prefer to indicate annuity payments in the contract. The loan body will be repaid faster with differentiated payments. In the first months, a significant part of the annuity payment will be interest, while the amount of debt remains virtually unchanged. This can be significant when refinancing or early repayment of a loan.

What is differentiated payment

The main advantage of differentiated payment is, first of all, the opportunity to save on interest. When calculating the monthly payment amount in this way, the loan amount is divided into equal parts over the entire loan period. Thus, interest is calculated on the actual remaining amount of debt and will gradually decrease towards the end of the term. In this case, the largest amounts are paid by the borrower during the months of using the loan; with each subsequent payment, the amount will decrease significantly.

It should be taken into account that depending on the number of days in the month and the balance of the loan amount, different interest will be calculated, and therefore the monthly payment will be different. The contracts pre-calculate the monthly payment, and banks often inform their clients about changes in the payment amount through available communication channels. But before paying, it would be a good idea to call the bank back and clarify the amount that needs to be deposited.

What is a differentiated loan payment?

A differentiated type of payment, unlike an annuity, implies a change in the amount of the monthly payment over time. This change occurs due to the fact that when repaying a loan, the amount of the principal debt is reduced in equal shares, while the amount of interest decreases over time.

Debt differentiation is not very common in the banking services market, since on the one hand the profitability of the loan decreases, and on the other hand, borrowers refuse this type of payment due to the complexity of their understanding and calculation.

Advantages and disadvantages

The differentiated method of loan repayment, just like the annuity method, has its pros and cons. The advantages of differentiated loan payments include:

• savings on overpayments;
• convenient interest calculation scheme;
• reducing the payment burden over time.

In addition, it is worth noting that this repayment method also has disadvantages:

• high amount of payments in the initial payment period;
• increased requirements for the borrower;
• limited amount of funds provided;
• constant control of payments.

The difference between an annuity payment and a differentiated one

Since repayment methods differ significantly from each other, each type of payment has a number of advantages and disadvantages. Considering these features will help you make your choice. The table shows the amounts of payments as the debt repayment period expires.

Pros and cons of annuity payment

Annuity payments are, first of all, ease of use and understandable amounts of monthly contributions. But there are also a number of disadvantages.

pros:

• Debt repayment occurs in equal installments throughout the entire loan term.
• A clear payment scheme allows you to effectively plan your budget.
• Financial institutions do not impose special requirements on the borrower when making an annuity payment.
• The interest rate will be lower than with differentiated payment.

Minuses:

• Difficulties may arise if you repay early.
• As a result, the overpayment of interest will be greater than with a differentiated payment.

What is differentiated payment

Differentiated payment (commercial loan, classic loan, accrual of interest on the balance) is a method of loan repayment, by choosing which the borrower pays the principal amount (also called the “loan body”) of the loan in equal shares, while interest is accrued only on the balance of the debt. The borrower will repay the loan in equal installments over the entire repayment period, the payment amount decreases from month to month, but the “body of the loan” is distributed over the entire loan term.

As you already understand, the first payment will be the largest, and the last payment will be the smallest in amount for the entire loan term. You will have to tighten the belt at the very beginning and be prepared for large fees, but later it will become easier, the balance of the loan and the interest on it will decrease.

A differentiated payment is usually offered under a mortgage lending program; it is rarely seen when choosing a consumer loan. In general, if the loan is long-term, differentiated payments are willingly offered by banks, since it is profitable for them. However, in general, the benefit is less than with annuity payments, the total amount of payment with a differentiated scheme is lower, so the borrower is still more often offered an annuity.

Features of early repayment

If the borrower has the opportunity, the loan can be repaid ahead of schedule. There are two types of debt repayment: full and partial.

Complete

Full repayment of the loan is only possible if the borrower has the entire amount to repay the debt. At the same time, he is obliged to inform the bank of his intention no later than a month before the desired closing date of the loan. The bank calculates the entire remaining amount of the debt, which the borrower must repay ahead of schedule. After making the payment, the loan agreement is closed.

Partial

Partial early repayment of the loan debt implies that the client will make a monthly payment in excess of the required amount.

Early repayment schemes

There are two ways to repay a loan early:

• In the first case, repayment occurs by reducing the loan repayment period. To do this, you must make monthly payments according to the payment schedule, and available funds can be deposited to pay off several monthly payments. This reduces the number of months of payments. For example, instead of 30 months, the loan can be fully repaid in 16 months.
• In the second case, early closure of the loan occurs by reducing the debt. At the same time, the total number of months of making payments does not decrease, but only the amount of payments decreases. This is possible through monthly or one-time deposits of additional funds. Thus, in the future the borrower will contribute, for example, not 4000 rubles, but 3000, 2000, and so on.

Situations arise when it is difficult not only to repay the debt ahead of schedule, but also to pay the obligatory monthly payment. In such cases, the borrower’s reputation deteriorates and in the future it becomes problematic to find where to get a loan with a bad credit history without refusal.

Pros and cons of annuity payments

To understand how suitable the annuity type of lending is for you, you should analyze its advantages and disadvantages. Let's start with the positives. So, here are the advantages of annuity payments:

• You can get a loan for a larger amount.
  When calculating the maximum loan amount, financial institutions compare the size of monthly payments with the average income of the borrower. Since in the first half of the loan term the monthly annuity payments are significantly less differentiated, the maximum amount of the annuity loan will be greater.
• Gentle financial burden at the initial stage.
  In the first half of the loan term, it is much easier to repay an annuity loan than a differentiated loan. This is due to the smaller payments discussed in the previous paragraph.
• Convenient loan repayment.
  The client repays his loan debt in equal payments every month. He always knows the exact amount that needs to be paid, so erroneous underpayment on the loan is excluded. This will save the borrower from accidentally incurring debt, and therefore from fines.
• Conveniently plan your budget.
  The client pays fixed annuity payments, which means that the same amount will be deducted from his budget every month. As a result, the borrower forms a new permanent budget for a “reduced” amount, the costs of which are more convenient to distribute and plan.
• You can use credit money longer.
  The annuity scheme provides for a slower (compared to the differentiated scheme) reduction in the loan amount in the payment schedule, which allows the client to use borrowed funds longer.

Agree, the listed advantages of annuity payments are really impressive! However, don't be so quick to clap your hands! The fact is that this type of lending has two significant disadvantages. Here they are:

• More overpayment on the loan.
  An annuity loan will cost the borrower more than a differentiated loan. This occurs due to the fact that the body of the annuity loan decreases more slowly. And since interest is accrued specifically on the loan body, the borrower has an overpayment of interest.
• The amount of payments is not reduced.
  On the one hand, fixed payments are convenient. But it is much more convenient when they are reduced. Unfortunately, the amount of annuity payments does not change, but differentiated payments are constantly decreasing and by the end of the loan period they become much less than the initial loan payments.

Well, friends! Now you know what annuity payments are, as well as their pros and cons. Surely you want to see specific examples with formulas and calculations. No problem - move on to the next publication.

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Is early repayment beneficial for an annuity loan?

First of all, early repayment is beneficial to the borrower. In this case, interest will be charged on the outstanding balance, which will significantly reduce the amount of interest payments. For example, if a loan is taken out in the amount of 50,000 rubles and 10,000 rubles are paid ahead of schedule, then interest will already accrue on the remaining 40,000 rubles.

In turn, it is completely unprofitable for banks to repay the loan early, since in this case the financial institution does not earn on interest.

How to calculate overpaid interest

After early repayment of the loan, it is possible to return overpayments of interest or commissions. To qualify for such a service, you must first take into account several factors:

• You should carefully read the terms of the loan. Some financial institutions do not provide the option of early repayment of a loan if taken out within a month.
• It is necessary to correctly pay for the early repayment of the loan. To do this, you need to promptly notify the bank of this intention, write an application and deposit the required amount into the account.
• After closing the contract, you should obtain a certificate from the bank confirming that there is no debt on the loan.

The borrower can calculate the amount to be repaid himself. To do this you need:

• The amount of accrued interest for the entire loan period must be found out from the payment schedule.
• Calculate the amount of interest paid and the loan repayment period.
• Divide the cost by the loan term and multiply by the actual loan repayment time. The amount received will be equal to the interest that should have been paid by the borrower.
• The amount for actual use of the loan must be subtracted from the amount of interest paid. The resulting difference is the overpayment of interest.

After this, you must fill out an application and attach a copy of the loan agreement to it. You can contact your financial institution with these documents.

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