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The annuity loan

Everything you need to know about the subject

Banks not only keep the deposits collected from customers, but also place some of them as loans. Most of these loans are annuity loans.

The annuity mortgage loan
To better understand how an annuity loan works, you need to know the meaning of an annuity.

What is an annuity?

A series of equal cash flows (deposits or payments) that are due for a specified period of time.

Why is it called an annuity loan?

The repayment of the annuity loan is due to a certain maturity, all repayments are the same and the interest and principal ratios differ within the same repayment installments. If I want to represent the proportions, it looks like this.

The annuity mortgage loan repayment
The ratio is different, but the sum is the same.

What happens when you take a loan from a bank?

Although I fully agree with the central banks’ commitment to responsible lending, this is unfortunately exhausted in most cases by the fact that half of the forest is cut down merely to print information related to the loan. After all, not many people read it carefully. (Because he had already decided that he needed the loan, after all, Aunt Mary told her to pick it up, and the neighbor had it, and so that he wouldn’t miss it, he would tick the parking meter outside).

Then, as an individual, if you are not applying for an overdraft or credit card, your repayment will almost certainly be an annuity repayment. This is the best to count with for the average person. The bank employee may have told you orally and also issued in writing that you will pay more interest than principal in the beginning, as well as the APR value of the loan. Above that, however, many slip away and are not recalculated.

What’s the problem with not counting in advance what a credit decision means?

I understand that the bank is pricing the risk, and the bank is nothing more than a business anyway. The business needs money to operate, and there is no other way to do it at the banks. But that the next commercial could go smoothly during prime time without raising questions, I feel strong:

Who likes good things? Me-meee-meeee!!

Who wants to pay for them? Well…

I have such good news that you can have everything you could want without having to pay a single penny for it … today.
Lowercase: APR 39.9% (End of advertising)

One tends to see the future as pinker. It is no different with loans either. Looking at the Hungarian central banks’ commodity loan search application, the vast majority of personal loans to be repaid with an annuity loan fall in the 10-15% APR range.

That’s if you want to make any credit decisions, reconsider what you’d sign up for. Maybe that’s what decides whether you are able to pay.

What are the risks of an annuity loan?

Interest rate risk

At least in Hungary, the loans on foreign currency are no more available. Since the disbursement of loans on a forint basis, many people believe that their repayment installment can no longer change. Yet credit remains at risk.

As you’ve seen in the ratios above, with a few exceptions, you pay far more interest at the beginning of the term than you do in principal.

Thus, the first risk of an annuity loan is nothing more than interest rate risk.

The interest rate on a loan can be fixed or variable.

Interest rate risk in the case of fixed interest rates.

In the case of a fixed interest loan, it is also included in your loan agreement when determining the interest rate. As interest in the appropriate legal language, the description means, for example, a fixed 5% throughout.

In the case of a fixed interest, the interest rate is the same throughout, but if anything happens to your income and you have a problem repaying the loan, know that almost the entire loan you have is affected by the delay.

And because fixed-rate loans are slightly more expensive, there are often fewer amounts left to repay the principal. That is, it decreases slower and the delay affects a bigger part.

Interest rate risk for variable interest rates

Bank loans are typically adjusted for interbank interest rates. In the case of forint loans this is called a BUBOR. (In the case of an euro loan, it would be LIBOR). The interest period and the interest surcharge are described in the interest-determining part of your loan agreement. Something like this is described: 3 months BUBOR + 0.5%

Variable interest rates are already more risky in terms of repayment. Even then, whatever happens to your income, it affects almost all of the capital raised. It also lives up to the fact that an annuity loan means the same amount of cash flow throughout. It remains the same until the interest rate changes at the end of the interest period (3 months, 6 months, 1 year, 5 years, etc.). Then, with the new conditions, the bank recalculates your existing loan and sets your repayment with this new interest rate.

If you look at the picture below of the data recorded by the MNB on the development of BUBOR, you can clearly see that the interest rate level has been very low for a few years now, so an increase is expected.

3 months BUBOR rate 2000-2020
Quick tip: You’re fine if you’re now asking for a fixed interest rate on your loan from your own bank or just a loan redemption. I can help you with that, you can contact me here. This is because you fix a lower interest rate, so later, if the interest rate goes up, it doesn’t affect you. After the central bank raised the interest rate, you will no longer be able to do that.

Exchange rate risk

Since the withdrawal of foreign currency loans (at least in Hungary), this has not affected many people, but if you had a Swiss franc loan among your acquaintances, I do not have to explain this risk.

At that time, the capital was denominated in foreign currency, and the bank was also waiting for repayment in foreign currency. If the exchange rate of the Swiss franc / euro / any other currency has shifted, it has also affected your installment.

What does repaying an annuity loan look like in the case of a home loan?

Take the example that a couple wants to move into a new house, for that they need 15 million forints, and they would like to take this out as a home loan for 20 years. Let it now be a plain home loan, and as we have discussed, the vast majority of loans are annuity-loan. This loan will be no different. In our example, we now look at a 5%, fully fixed interest rate.

Let’s see how their repayment goes. The bank is always paid HUF 100,303 per month. Being that it is an annuity loan, so there is an increasing rate of principal repayment. At the beginning a little less and then always a little more.

Annuity loan repayment

Maybe you’re already seeing why the bank doesn’t care if you want to gamble to inflate an annuity loan. That is, you wait until price increases due to inflation and subsequent wage increases make repayment easy.

In the first 7 years, you pay more interest than principal.

Where can an annuity loan slip aside?

A bank can make you a money-making machine very easily. And they will do this so that you will even be happy.

Suppose the couple mentioned above is contacted by the bank in the 8th year that the repayment has been in order so far, so it gives you the capital already repaid on a facilitated condition. The honey to make easier the choise that is neither a valuation nor anything else is needed, just sign it.

It offers you 4 million forints. Mhh… Sounds good doesn’t it? Reward 4 million! How good that is! It already has a place! Plus, because they give so much money, repayment has been 100 thousand per month so far, now it only jumps to 104 thousand. 4 thousand forints per month for 4 million. (The lowercase letter doesn’t really matter anymore, as it has become 25 of the 20-year term so far.)

Money rain

But wait! Never confuse the bank with the Maltese Charity Service! Because what’s really going on here is nothing more than that the bank has rewinded the wheel of time.

Repayment with new condition

You can see that from here, the interest payment on the annuity loan jumped back to its original level. If the offer is not accepted, the total repayable interest is HUF 9,072,776 over 20 years. Which is still close to the amount raised. If accepted, it will give the bank HUF 12,650,279 over 25 years. So 3.5 of the 4 million raised have already been returned as interest.

While the bank has made you a cash-generating machine for more than 10 years period who pays more interest than principal, seeing proper payment discipline, obviously they won’t be too interested in where you put that half-million actually.

How can you get rid of an annuity loan the fastest?

Prepayment.

In the case of annuity loans, you also have the option to pay extra capital in addition to the normal installment. This immediately goes into the capital, thus reducing the amount for which the bank calculates interest.

You must always notify the bank in writing of the prepayment, it is not enough to simply pay. You can then declare that the term will be reduced or the installment. Be aware that if you received a start-up discount from the bank, it may not be worth prepaying at the beginning of the term. The relevant regulations are set out in your contract.

Credit redemption.

During the loan redemption, another bank will pay off your existing loan in full and you will pay a new annuity loan according to your own condition.

Ideally, this is what the effect of a minimal interest rate change of less than 0.5% looks like.

Repayment with redemption

In your opinion, if a few tenths of a% results in such an effect, then what can a e.g. 5% APR debt settlement loan replacing 10-15% APR personal loans?

Questions:

  1. How do you choose a bank for when it comes to borrowing?
  2. Do you have a loan that, although an annuity loan, you think you could get the same significantly cheaper?
  3. How often do you review your loan to know if there is a better deal on the market for you?

While credit alone is not bad, its ill-considered use is. If you are also affected by the issue or are about to borrow, you can contact us here.

You can access this article in Hungarian and German
Hungarian flag Az annuitásos hitel
German flag Das Annuitätendarlehen

 

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