The difference between annuity and differentiated payments

When taking out a mortgage loan, people often pay attention only to such points as the amount of the down payment, the loan term and the interest rate - while such an issue as the repayment method does not come into view. However, the mechanism for calculating payments and accruing/collecting interest, and ultimately the total amount of overpayment on the loan, depends on it.

We are talking about differentiated or annuity schemes; today a number of banks allow borrowers to independently choose one of them. In this article we will take a closer look at the advantages and disadvantages of an annuity.

Annuity payment: what is it?

Payment under the annuity scheme is the most common and involves paying off the debt in equal installments over the entire loan term without changing the contribution amount. The payment includes two components - the principal debt and interest accrued by the lender. The specificity of the annuity is that at first almost the entire payment amount goes to pay off interest, and the principal debt decreases minimally. Over time, the ratio changes, and the largest part of the payment goes to repay the principal debt. Banks do this in order to insure themselves - by receiving interest in advance, even if the mortgage is paid off early, their losses will be minimized.

The differentiated scheme involves making large contributions every month, the amount of which is gradually reduced. With this scheme, throughout the entire period of lending, the principal debt is repaid in equal parts, and interest accrues on top of the fixed amount. When the loan is repaid ahead of schedule, the overpayment is also reduced, and the larger the amount and the longer the loan term, the more noticeable the difference will be.

Annuity payment

This is a type of mortgage repayment calculation in which the monthly payment remains constant throughout the loan term.

The fixed amount of the monthly payment is obtained due to the fact that the part of the money going to repay the loan body increases over time, and the part going to pay interest for using the loan decreases. This means that in the first months of the mortgage the borrower mostly pays interest to the bank, and only by the middle of the loan term does the amount used to repay the principal debt increase to significant amounts. Since the amount of the principal debt decreases slowly, more interest is accrued on the remaining debt. The overpayment on the loan in this case can be quite significant.

Schedule

You can clearly imagine the principle of forming an annuity payment by looking at the graph below.

Calculation formula

• An - annuity monthly payment
• S - initial amount of principal debt
• P — loan interest rate
• N—loan term in months

This formula is used in all credit institutions and is used in most credit calculators.

Table

Calculation of monthly annuity payments can be seen in the table. As an example, consider a loan of 500 thousand rubles with a repayment period of one year, at 14% per annum.

pros

• Fixed payment for the entire loan term, allows you to plan your budget
• Banks are more loyal to borrowers applying for an annuity loan repayment scheme.

Minuses

• Significant overpayment of interest for using credit funds
• When refinancing a loan, losses may outweigh the benefits

Advantages and disadvantages of an annuity

The annuity scheme definitely has its advantages. The first is its simplicity; in everyday life, this scheme is more convenient - a person is always aware of the size of the payment the bank expects from him every month. This makes it possible to plan expenses in advance. Keeping a fixed number in mind is much easier than regularly checking the amount in the payment schedule. If the goal is to reduce the monthly payment amount to a minimum by stretching out the payment period, then an annuity is well suited for this. Do not forget that the longer the loan term, the higher the overpayment of interest.

Another advantage of the annuity scheme is its accessibility; today any bank gives the opportunity to use it for repayment. At the same time, there will be more loyal requirements for annuity borrowers than for those who prefer a differentiated scheme. The monthly payment on the annuity system will always be less than the first payment under the differentiated scheme, this allows you to take out larger amounts. The fact is that for banks, the ratio of the borrower’s income and expenses for servicing the loan is of paramount importance. Thus, annuity makes credit products more accessible.

Which is more profitable?

From the point of view of overpayment of interest, an annuity will always lose to differentiated payments. Their main disadvantage is the large amount of down payments. And as the loan amount increases and its term decreases, the difference will become more and more noticeable. Here you need to first look at your income level. If you are able to make large contributions, a differentiated system will be preferable. If at first it is more comfortable to pay less, then it is better to choose an annuity.

Let's do the math with an example. Since each bank offers its own conditions regarding the schedule/payment of contributions, the final figures are indicative, but most often the calculation will be the same. Let's assume that the borrower takes out a mortgage loan in the amount of 3 million rubles, at a rate of 10% per annum for a period of 5 years. If he uses an annuity, then the monthly contribution throughout the entire period will be 63,740 rubles per month. At the same time, he will overpay 824,470 rubles in interest. If he uses a differentiated system, then the limits of the monthly payment amount will gradually change - from 75,000 rubles to 50,412 rubles. The overpayment of interest will amount to 762,500 rubles.

What are graduated mortgage payments?

Each loan under any repayment system consists of 2 parts: the amount of debt and the interest part. Differentiated (decreasing) payments are a method of loan repayment in which you pay the loan body in equal installments, and interest is charged on the balance of the debt. In the first quarter of the loan term, you will have to make the largest payments, and in the future the amount of monthly payments will decrease.

Few banks offer mortgages with differentiated payments. This is due to the fact that in this case you immediately begin to repay the loan amount. For the bank, this situation is unprofitable, because interest is considered the main source of its income. In case of early repayment, the borrower will be able to save a significant amount of money. More popular banks such as Sberbank, VTB, Otkritie do not have these types of mortgages.

Formula for calculation

You can calculate your mortgage payment yourself using formulas.

Basic payment – ​​C = A/D , where:

• C – monthly repayment amount of the loan body;
• A – the size of the mortgage loan;
• D – mortgage term in months.

The percentage part is calculated using the formula – S=R*L/12 , where:

• S – accrued interest;
• R – debt balance for a given month;
• L – annual interest rate on the mortgage.

R=A-(C*n) , where n is the number of loan payments paid.

Analysis by example

Let's calculate the differentiated mortgage payment if, for example, you decide to take 2,000,000 rubles at 12% per annum for 15 years (or 180 months). The main payment to repay the debt will be: 2,000,000/180 = 11,111.11 rubles.

Now let’s calculate how much you need to deposit into your account every month:

On the websites of banks that provide loans with differentiated payments, you can find a special calculator and do not count everything manually.

Early loan repayment

Remembering that they overpay more with an annuity, many borrowers strive to at least partially repay the loan ahead of schedule; all Russian banks allow this. There are options to choose from: you can either reduce the monthly payment or shorten the loan term. Here you need to decide on your priorities in advance: either you need to give less money to the bank, or reduce current expenses. As the repayment period decreases, the total overpayment of interest also decreases, which is logical - the borrower uses the loan for a shorter period, so he must pay less interest.

If the borrower has the task of reducing the monthly payment, then additional funds are immediately freed up. There is another option that experts consider the most optimal. It consists of continuing to pay the initially established amount after the mandatory payment has been reduced. This allows you to shorten the repayment period. Also, if the financial situation worsens, it will be possible to reduce the load and pay only the minimum payment.

This scheme also has a drawback; it consists in a larger overpayment of interest compared to shortening the term. Regardless of the chosen option, annuity borrowers need to understand that the benefit from repaying the loan ahead of schedule always directly depends on how much time is left to pay on the loan. As the end of the term approaches, the benefit of early repayment decreases.

Additional recommendations

When applying for a mortgage loan, you need to objectively assess your capabilities and calculate your budget for the years ahead. Experts believe that the monthly mortgage payment should not be more than 40% of family income - otherwise there is a risk that you will have to cut back on spending on everyday needs. The payment schedule, as a rule, is formed at the stage of concluding the contract, but preliminary calculations can be made independently using mortgage calculators - they are freely available on the Internet.

What does annuity payment mean?

With the annuity payment method, you will make equal payments throughout the entire loan term. Stability is great, but in the first months most of the payment will go towards paying interest. By the end of the mortgage term, the situation will change: the principal amount will go to pay off the loan body.

The principle of equal monthly payments is that initially you are forced to pay the bank most of the interest, and only then pay off the principal debt. This is especially true if you decide to pay off your mortgage early.

Formula for calculation

The size of the annuity payment is calculated using a complex formula: Mn = Сз*(Mpc/(1 – (1 + Mpc²))

In this formula:

• MP – the amount of the monthly mortgage payment;
• Сз – loan amount;
• Mpc – interest rate per month;
• Sk – mortgage term in months.

Analysis by example

Calculating equal payments is quite complicated, so let's look at it with an example. Let's take the following parameters:

• mortgage amount – 2,000,000 rubles;
• interest rate – 12% per annum;
• term – 15 years.

Mpc = 12/100/12 = 0.01%.

The calculation of the annuity payment in this case is as follows:

2,000,000*(0.01/(1-(1+0.01)-24)=24003.36 rub.

This is exactly how much money you will have to deposit into your bank account every month.

The ratio of the interest part and the principal debt in the first 5 months can be seen in the table: