# What is an annuity?

What is an annuity?
Annuity is the annual repayment of the annuity loan.

The term annuity comes from the Latin of annus , which means year. The annuity consists of the two components interest and amortization.

As the remainder of the loan becomes smaller and smaller during the repayment of the loan, the interest charge is reduced accordingly so that the annuity portion of the annuity increases to the same extent.

However, the sum of interest and principal always results in the same annuity over the life of the loan.

In practice, annuity is usually not paid as an annual payment, but often on a monthly basis. Here, too, the monthly installments include interest and repayment, which change from month to month, but remain constant overall and are thus constant for the year as well.

The loan calculator allows monthly, quarterly, semi-annual or annual installment payments by setting the installment interval.

## What is the processing fee?

The processing fee is a one-time fee when the annuity loan is paid out. Often, instead of a processing fee in practice, the closing fee is mentioned. The loan calculator optionally allows such a fee to be included in the calculation.

Because the processing fee is payable directly upon payment of the loan amount, it basically reduces the amount of the loan. Instead of a fee is sometimes spoken of a discount or disbursement.

At a percentage fee depending on the amount of the loan amount, the amount of fees is initially calculated manually and can then be entered in the loan calculator.

Although the processing fee is due immediately upon loan payment, the loan calculator allows the fee to be included in either the repayment installment or to be assumed to be a separate payment.

In the case of inclusion in the repayment rate, a correspondingly increased initial debt is assumed and this is taken as the basis of the calculation.

A processing fee always has an impact on the effective annual interest rate. Especially with a short loan term, the processing fee increases the annual percentage rate considerably. The longer the runtime, the lower this effect.

## What is the monthly annuity? Calculate the monthly annuity

Buyers of real estate or home builders often inevitably come into contact with the term annuity.

Annuities play a large role in financial mathematics and describe an annual amount, for example, to repay a installment loan.

The monthly annuity results from the interest rate and the repayment amount.

For an annuity loan, the monthly annuity consists of an interest and an amortization installment, with the interest portion of the first installment being relatively high. At the last installment, the repayment installment is highest.

## How is the monthly annuity calculated?

During the fixed interest period, the monthly annuity remains constant, while the interest portion decreases over time and the repayment portion increases. For each monthly installment, part of the loan is repaid.

As a result, each monthly payment not only reduces the residual debt but also the interest portion, while the repayment portion increases by the interest portion saved.

The borrower often has the choice between terms of 5, 10, 20 or more years in the fixed interest rate.

## Annuity loan - what should be considered?

Annuity loans have the advantage that they are constant and therefore easy to plan. With variable annuity, it should be noted that the level of the interest rate may change.

The interest rate is based on the market interest rate. In a downturn or in times of crisis, interest rates tend to be low, while an upswing with rising interest rates must be expected.

This may also increase the costs associated with the loan. However, there is the possibility to limit extreme increases by a so-called interest cap. However, this must be agreed with the bank.

What is the difference between annuity and repayment loans? Repayment loan vs. Annuity Loan
Most loans that are eligible for start-up and self-employment must be repaid during the loan term. Only a few loans are final, so they are not repaid, but only repaid at the end of the term.

For the loans that are repaid during the term, a distinction is made between the repayment loan and the annuity loan. In the repayment loan, the repayment rate remains the same over the entire term, but the interest charge is lower from month to month. In the case of the annuity loan, on the other hand, the entire burden consisting of principal and interest remains the same.

## Two important questions in advance

Before starting a loan as a founder or self-employed person, you should answer two important questions in advance:

• How much capital do I need for my company at what time?
• What loan amount can I afford?

The first question is about determining the optimal loan amount. Especially in business start-ups, it is often the case that in the first 6 to 18 months more money is spent than is taken. In other words, capital requirements are rising steadily. With a well-prepared financial plan, you can determine the maximum amount of capital needed and hence the optimal loan size.

The second question concerns the long-term financial impact of the loan amount. A loan improves your liquidity. If a loan is paid out, your balance will increase. However, from the date of the loan disbursement, you perform debt service: you pay interest and, as a rule, repayments on the loan. In other words, money drains every month. Therefore, you have to ask yourself what loan amount you can afford.

A first impression of the monthly charges is provided by our amortization calculator, which you can use to calculate your loan. Depending on whether you choose a repayment loan or an annuity loan, the monthly burdens are different.

## Repayment loan: Consistently equal repayment installments

If you opt for a repayment loan, the monthly repayments remain the same. You can easily calculate this: the repayment installment is the loan amount divided by the number of months of the loan term.

With each repayment, interest rates fall, as the residual debt decreases with each repayment installment. Due to the decreasing interest charge, the entire burden consisting of redemption and interest is continuously reduced over the term of the repayment loan.

An example from our loan calculator:
• You take out € 60,000 loan at 5% interest with a term of 60 months. After 60 months, you have repaid the loan.
• Then you pay € 1,000.00 each month
• Charge in the first month: € 1,250.00 = redemption € 1000 + interest € 250
• Last month's debit: € 1,004.20 = redemption € 1000 + interest € 4.20
• Paid interest over the entire term (60 months): € 7,625.00
As you can see, the monthly total interest and principal payments decline. Different with the annuity loan.

## Annuity Loan: Consistently consistent pay

In contrast to the repayment loan, the annuity loan is the same as the total monthly charge consisting of the interest and repayment installments over the term of the loan. So you always pay a monthly amount, a so-called annuity. The repayment rate increases with increasing maturity, while the monthly interest charge decreases continuously. In other words, at the first payment of the annuity, the portion of the repayment payment is low, while the interest portion is high. If you pay the last annuity, the reverse is true: the repayment is high and the interest is low.

The advantage of the annuity loan is the constant monthly burden that you can easily plan with. The disadvantage is that the effective interest charge is slightly higher than the repayment loan. How big the difference is exactly, you can calculate yourself with the help of our loan calculator.

Let's take an example from our loan calculator for the annuity loan. We work with the same numbers as the repayment loan, so you can see the difference clearly:
• We remember: € 60,000 loan at 5% interest with a term of 60 months. After 60 months, you have repaid the loan.
• monthly total annuity over 60 months: € 1,132.27
• (calculated using a not so simple financial mathematical formula)
• Month 1: Amortization amount is € 882.27, interest portion is € 250 (totaling 1,132.27)
• Month 60: Amortization portion = € 1,127.58, interest portion € 4.70 (returns 1,132.27, our constant annuity)
• Paid interest over the entire term (60 months): € 7,936.44
• This is in comparison to the repayment loan by € 311 more interest.
As you can see, the annuity portion of the annuity loan increases in proportion to the total monthly burden. In addition, the annuity loan is more expensive than a repayment loan with the same conditions.