Amortizing is the same as repaying a debt. Usually, a number of installments are made over an agreed period of time, for example for a few months or for several years, but even if you repay everything as a lump sum, it is counted as an amortization. Many sms loans are repaid as a lump sum, but today there are many sms lenders who offer sms with partial payment if you borrow for longer than 1 month.
When you repay a loan, you not only repay what you have borrowed, but also pay the interest in connection with your repayments.
Amortization with annuity
Many private loans are amortized with annuity, so we start to look at how annuity loans work. There are two different types of annuity loans, loans with changed annuity and with retained annuity.
Changed annuity (genuine annuity)
- If you have taken out a loan with a modified annuity, you pay exactly the same amount every month, even if the interest rate goes up or down. Should the interest rate go up, you pay more in interest and pay less and vice versa.
- The maturity of your annuity loan can change before it is paid off, but only if the interest rate changes. An interest rate increase means that you have to pay off the loan for a longer period than planned and vice versa.
- The reason why loans with changed annuities are also called loans with genuine annuities is that the repayment amount is constant no matter how the interest rate develops.
- The advantage of changed annuity is that you know exactly how large your payments will be throughout the term and the disadvantage is that you do not know exactly when you get rid of the loan. Thus, it is easier to plan their finances in the short term but not in the long term.
Retained annuity (false annuity)
- If you have taken out a loan with retained annuity, you know exactly how long you will pay off the loan even if the interest rate changes.
- An interest rate increase means that you have to pay more at each amortization opportunity and an interest rate cut means you have to pay less.
- The reason why a loan with retained annuity has a so-called “false annuity” is that you cannot know in advance how much you will be able to pay at each payment opportunity because the interest rate can change.
- The advantage of retained annuity is that you know exactly what day you will have paid off on the loan and the disadvantage is that you do not know how much you will be paid at each installment. Thus, it is easier to plan their finances in the long term but not in the short term.
Some private loans and almost all mortgages have a straight repayment that works like this:
- You repay exactly the same amount on all payment occasions and in addition you pay interest.
- Since your loan drops after each payment, your interest expenses also fall, it is only if the interest rate goes up that it may not do so in the short term. A straight repayment means that you pay less and less until you have paid off the loan clearly.
- The advantage of straight amortization is that your monthly or quarterly payments decrease rapidly. The disadvantages are that a sudden increase in interest rates can make it tough for you and that you get to pay off pretty much in the beginning.
If you have an amortization-free loan, you do not repay anything at all, but only pay interest on the loan, but it is only mortgages that can be amortization-free and usually you start paying off the mortgage after some time.
However, an amortization requirement for mortgages is expected to be introduced in June 2016, which means that only those who have a loan-to-value ratio of no more than 50% can receive an interest-free loan, all others must repay at least 1 or 2% of the loan’s original size, depending on the loan-to-value ratio.