Annuity vs differentiated payments: what’s the difference

The “repayment method” clause in a loan agreement is easy to skim past. Yet it decides how your monthly payment behaves and how much interest you pay in total. Banks and non-bank lenders use two main methods: annuity and differentiated.

Annuity payments

With an annuity you pay the same amount every month for the whole term. Early on, most of that amount is interest; as the balance falls, the interest share shrinks and the principal share grows.

All Finex Kredit loan products are repaid on an annuity basis. The reason is simple: equal payments make planning easier, especially for households on a steady income and small businesses with a fairly even monthly turnover.

Differentiated payments

With a differentiated schedule the principal is split into equal parts and interest is charged each month on the outstanding balance. The first payment is the largest and each one after that is smaller.

Same loan, two methods

Let’s use identical terms: AZN 10,000, 24 months, 28% a year.

Annuity:

• AZN 548.88 every month;
• total interest AZN 3,173.24.

Differentiated:

• principal falls by AZN 416.67 each month;
• first payment AZN 650.00, second AZN 640.28, last AZN 426.39;
• total interest AZN 2,916.67.

The differentiated schedule saves about AZN 256 in interest, but in the first months the payment is almost AZN 100 higher than the annuity.

Where the difference comes from

Under a differentiated schedule the principal falls faster from the start. Interest is always charged on what you still owe, so less of it builds up. With an annuity the balance falls more slowly at first, so a little more interest accrues.

That doesn’t make an annuity “expensive”. You simply pay less at the start and keep part of the money for longer — the interest difference is the price of that.

Which one suits you

An annuity is usually better when:

• your income is stable and you want to set aside the same amount each month;
• a lighter burden in the first months matters, for example until a business investment starts paying off;
• you want a simple budget.

A differentiated schedule is better when:

• your income is high now but may fall later;
• you can handle larger payments early and want to keep total interest to a minimum.

Paying early

Under either method, repaying part or all of the loan early reduces interest, because interest is charged on the outstanding balance. Check the early-repayment terms with a specialist before you sign.

What to compare

1. 1The highest monthly payment — under a differentiated schedule that’s the first one.
2. 2Total interest.
3. 3Commission and other costs, which the effective annual rate (FİFD) captures.
4. 4How stable your income is.

The bottom line

How to read a payment schedule

A schedule shows four figures for each month: the payment, the part that repays principal, the part that pays interest, and the balance left afterwards. With an annuity the payment column is the same every month, the interest column shrinks and the principal column grows. With a differentiated schedule it’s the other way round: the principal is constant and the payment falls each month.

Pay particular attention to the balance column. If you’re thinking about repaying early, that figure tells you roughly how much you’d need to close the loan in any given month.

Common mistakes

• Deciding on the first payment alone — under a differentiated schedule it’s the heaviest, and under an annuity the balance falls slowly at first.
• Ignoring total interest.
• Forgetting the commission, which raises the real cost under either method.

Frequently asked questions

Does Finex Kredit offer differentiated payments? At the moment all loan products are repaid on an annuity basis.

Can I reduce interest on an annuity loan? Yes — repaying part of the loan early reduces the balance and therefore the interest. Check the terms before you sign.

An annuity is predictable and easy to budget for. A differentiated schedule saves a little interest but is heavier at the start. The Finex Kredit calculator shows the annuity payment, the full schedule and the effective annual rate — try it with your own numbers and pick what you can comfortably repay.