Three ways to pay off loans
A loan as such is a practical matter, whether for real estate financing or a car purchase. Of course, a loan must always be repaid or repaid. Depending on the type of loan repayment, there are three different variants.
- The annuity loan
- The deposit loan
- The term loan
The most common variant is undoubtedly the annuity loan. The procedure is the same for both mortgage lending and classic personal loans.
- The annuity loan is the most common type of loan, for example, for personal loans or mortgage lending. At the same time, the monthly rate remains constant because the interest and redemption components change within the rate.
- With annuity loans, low interest rates shorten the term.
- With the rare payment loan, the rate becomes smaller and smaller. The redemption portion remains constant, but the interest portion decreases monthly.
- For a term loan, only the interest is paid each month. Only at the end of the repayment is due in a buzzer. This model comes, for example, in policy loans to bear, so if a life insurance loaned.
The annuity loan
For an annuity loan, both borrower and lender agree a fixed annual rate, the annuity. If the loan amount is 100,000 Euro, the interest rate is 3 percent and the initially agreed repayment amount is 2 percent, the annuity amounts to 5,000 Euro, 3,000 Euro interest and 2,000 Euro repayment.
The borrower pays 5,000 euros to the lender each year until repayment. This also clarifies the concept of initial repayment: If the rate remains constant, the repayment share inevitably increases in the installment because the interest burden is always calculated only on the residual debt. The residual debt is reduced, the loan rate remains the same and therefore the repayment portion increases
The logical consequence is that the repayment of the loan will be faster and faster over time. If we stick to the above example, the following structure results within the annual annuity:
The repayment in the first year of 2,000 euros, the interest rate in the following year is only expected to 98,000 euros. As the rate retains the same amount but the interest rate decreases, the redemption amount increases accordingly. The interest in the second year is still 2,940 euros, the repayment within the annuity increases to 2,060 euros.
Higher interest rates mean shorter terms
Basically, the lower the interest rate, the longer the loan runs. In our example, the loan term is 31 years. At an interest rate of five percent, the loan term is reduced to 26 years. How come?
The interest is calculated on the total balance of the loan. With low interest rates, the share of interest payments decreases more slowly, which means that the repayment share within the installment can only rise more slowly.
In the case of an annuity loan, therefore, it is always advisable to set the repayment installments higher the lower the interest rates are.
Important for an annuity loan is also the time of the repayment settlement. Regrettably, it is common for the repayment settlement to take place only once a year, at the end of the year. Although the borrower repatriates part of the loan every month on a monthly repayment, he pays the interest on the remaining debt for a period of one year, which existed on January 1 of each year.
This situation applies to installment loans as well as to mortgage loans.
The deposit loan
The pay-off loan is hardly used in practice. While the annuity portion of the annuity loan increases within the installment and the interest portion falls, the installment loan loses interest, the repayment always relates to the initial loan debt and remains identical.
Assuming that the loan amount is again 100,000 euros, the interest rate three percent and the repayment two percent, this results in a rate in the first year of 5,000 euros.
In the second year, the repayment is again 2,000 euros, interest, however, fall only in the amount of 2,940 euros, three percent on the remaining debt of 98,000 euros. In our example, the loan term is extended to 50 years for a repayment loan.
In the graphic analysis, the following picture emerges:
Withdrawal loans only make sense in practice in very few exceptions and therefore hardly occur anymore.
The term loan
A term loan usually consists of two legally independent contracts. Until the introduction of the Retirement Income Act, the term loan was a popular financing instrument for externally rented residential property.
The borrower pays in this variant, only the interest to the bank. The repayment takes place via a separate savings plan, for example a life insurance or a home savings contract. With the abolition of the tax privilege for life insurance, however, the bullet loan became increasingly uninteresting.
The advantage was that the loan was not repaid during the term and the tax deductible interest remained the same for the entire term. The payment from the life insurance took place and becomes tax-free with contracts with politics before 1 January 2005.
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The most widespread application for bullet loans today is in home loan financing. If the Construction loan contract is not yet ready for allocation, but the real estate buyer needs a loan, the Construction loankasse offers a bridging loan.
The Construction loaner serves on the one hand the Construction loan contract until the allotment and pays on the other side only the interest for the interim financing. With the allocation of the Construction loan contract, the interim financing loan will be repaid in one sum.
Definitive loans always make sense if it is interesting for the borrower to claim the highest possible interest burden for tax purposes. The way in which the capital formation for the final repayment takes place remains up to the borrower.
Life insurance policies can still be used, and conservative funds are also suitable. However, it is important that the savings contract is assigned to the lender.
Accurate arithmetic is important because the taxable benefit from the deduction of interest on debt is offset by the taxable income from the savings contract. Depending on the construct, this could potentially level the tax benefit.
Especially at times of extremely low lending rates, income from fund savings plans can ultimately lead to an overall higher tax burden.
For private borrowers, the classic annuity loan represents the most sensible financing option. The repayment loan is rarely used.
The tax advantages and disadvantages of a term loan have to be checked very carefully and compared with the total expense of the annuity loan without tax benefit.