The choice of the bank, currency, repayment period – these are just some of the dilemmas that the future borrower faces. You need to decide on another important issue – choose decreasing or equal installments. This decision will not less affect our finances over a dozen or so or several dozen years, than the issue of interest or currency. In the latter matter, choice is always the most difficult , because it requires us, if not visionary skills, at least seriously consider our future financial strategy related to saving and investing, as well as determining our future potential financial opportunities.
We have two repayment options to choose from: repayment in equal installments and repayment in decreasing installments.
The installments we pay back consist of 2 parts: capital and interest. Capital is the money we borrowed from the bank to buy an apartment. Interest is the price charged by the bank for making this loan available to us. The differences between equal and decreasing installments are actually a different combination of the two components of the installment.
When we choose installments equal throughout the loan repayment period, our monthly payments to the bank will be the same. In this case, the principal part of the installment systematically increases over the entire repayment period, while the interest part gradually decreases.
Initially, the greater part of the monthly repayment is interest, and a very small part – capital. These proportions change as more payments are made. At the end of the repayment period, a single installment already contains mainly a capital part.
At constant interest, the amount of equal installments is the same all the time. With a variable-rate loan , banks valorize the loan installment because repayment is calculated based on the interest rate applicable on a given day. In practice, this means that from time to time – usually on a quarterly basis – banks recalculate our repayment schedule taking into account the new interest rate.
This is because when the interest rate changes, the bank – wanting to keep the installment initially specified – would have to shorten or extend the loan repayment period so that neither party would lose. Instead, the bank prefers to maintain a fixed loan repayment period, so it recalculates the repayment schedule. As a result, the amount of repayments binding on the borrower changes over a set period, e.g. 3 months. The next correction may take place after the next change in the interest rate.
If we decide on decreasing installments, then throughout the entire loan period our monthly payments to the bank will systematically decrease. We will repay a fixed portion of capital every month, plus interest on the outstanding portion of the loan.
Repayment is determined as follows: the amount of credit granted is divided by the number of installments that we have to pay. We receive the amount of the monthly capital installment. By paying it to the bank every month, we reduce the amount of credit to be refunded.
Every month, the bank adds interest to the loan installment on a monthly basis. That is why repayments are the largest at the beginning, and then – with each passing month – they gradually decrease. If the system of decreasing installments is chosen, the capital part in each installment will be the same.
Who is the installment equal to?
When repaying a loan in equal installments, we start with lower amounts than those that we would have to pay with decreasing installments. Thanks to this, we don’t have to strain our home budget and leave more money in our pocket in the initial repayment period.
If we have trouble showing adequate creditworthiness, then the form of repayment can have a direct impact on the amount of credit granted by the bank. Therefore, due to the methods used by banks to assess creditworthiness (the smaller the monthly repayment of the loan, the easier it is to get it), choosing the form of equal installments we have a chance for a larger loan, because in the eyes of the bank we can afford it.
In the case of equal installments, the monthly installment – especially at the beginning – is much smaller than in the case of decreasing installments. For many people, it is not without significance that the repayment of the loan extends over time, thus paying smaller amounts to the bank, and the money saved in this way can be invested in such a way that the rate of return on investment is higher than the costs associated with loan interest rate.
The system of equal installments can be recommended to people who predict that their financial situation in the coming years will remain at the current level or even improve.
For whom the installments are decreasing?
If we choose a system of decreasing installments, the total sum of all interest that we will give to the bank over the entire repayment period will be lower than when we choose the system of equal installments.
This is because in the system of decreasing installments we pay back capital faster, which is why interest is calculated on a smaller and smaller amount each month. Decreasing installments are certainly not recommended for someone who has low creditworthiness and will not be able to cope with higher household budget charges in the early years of repayment.
Such a loan repayment system is, however, a good solution for those who can pay a lot for now, but anticipate that their situation may change over time. Therefore, they prefer to protect themselves and choose a repayment option that will require less and less financial resources over time. Also, those who want to pay off their loans as soon as possible and do not have the courage to take advantage of a shorter term (a shorter term is tantamount to a higher installment), will benefit by choosing decreasing installments. Due to the fact that they pay off their capital quickly, they will have less interest payable when they repay the entire debt.
What to choose?
Comparing the cost of the loan and taking into account the total amount of interest paid to the bank in relation to the amount of the loan, we can see that by choosing the form of equal repayments we will pay the bank more interest than when choosing decreasing repayments.
How much we pay
The difference results from the rate of capital repayment (it is greater when the repayment is decreasing) and thus the faster basis for calculating interest. However, it is worth paying attention to the fact that the money paid today has a higher value than the same money paid tomorrow. Therefore, if we consider the decline in the purchasing power of money over time, then it turns out that the cost of credit is almost the same, regardless of whether we choose the form of equal or decreasing repayments.
And one more thing – equal installments burden the household budget to a lesser extent in the initial repayment period, and thus allow – while paying back the loan – to systematically save. It is very important that the loan does not deprive us of the possibility of saving, which may occur when choosing decreasing installments.