When buying a property, you are faced with the question of financing. Sufficient equity is rarely available. The usual route is an annuity loan. However, there are alternatives. A so-called fully amortizing loan is a very attractive option. The prerequisite, however, is that the general conditions are suitable. What is a fully amortizing loan? What special features does it have, and when is it worthwhile for you to choose this form of property financing?
What exactly is a fully amortizing loan?
The name already indicates the special feature of this loan: At the end of the agreed term, you are debt-free. This means that a fully amortizing loan offers the highest level of planning security.
This form of property financing includes several components:
- A fixed term by the end of which you have repaid the entire loan.
- A fixed interest rate that applies until the end of the term.
- A comparatively high initial repayment component, which enables rapid repayment.
- Compared with other forms of credit, the total amount of interest payable is usually lower.
An important practical feature is the term. The typical period until the loan is fully repaid is usually ten to 20 years. Due to the rapid repayment, fewer interest payments accrue, and the loan tends to be less expensive. At the same time, it involves higher monthly instalments.
Difference from an annuity loan
In principle, this form of financing works similarly to an annuity loan. The key difference is the fixed agreed term. This means you do not need follow-up financing at the end of the fixed-interest period. This also means that, as a rule, you become debt-free more quickly. However, you pay for this advantage with a higher initial repayment.
How does a fully amortizing loan work?
If you choose this form of financing when buying a house or apartment, you should calculate carefully. The combination of the fixed-interest period and the term results in a higher monthly loan burden.
This is how it works: Contact your bank or credit service provider. Before doing so, you should decide within what period you wish to repay the entire required loan amount, including interest. The lender calculates an interest rate based on this term. This is projected for the entire term, to determine the final repayment amount. This repayment amount is then divided into monthly installments. You must then pay this amount every month.
There are two things to consider:
- Firstly, the monthly burden increases not only with the total loan amount, but also as the term decreases. The shorter it is, the higher the monthly installments become.
- Secondly, you generally receive significantly better terms if you choose the shortest possible term. The interest rate is often around 0.3 percentage points lower.
As with all loans, individual circumstances and market conditions play a role.
Special terms and early repayment fee
Because the term is calculated and fixed in advance, additional payments are not customary with a fully amortizing loan. The additional payments change the remaining term, causing the bank to lose interest income. If such repayment payments have been agreed, an early repayment fee usually has to be paid, with which you must compensate the bank for the lost interest payments.
What are the advantages and disadvantages of a fully amortizing loan?
As with all forms of financing, there are advantages and disadvantages. Therefore, before making a decision, you should carefully consider whether a fully amortizing loan is the best way for you to finance the purchase of a house or apartment.
The most important advantages include the following aspects:
- no interest rate risk,
- planning certainty,
- rapid repayment,
- interest advantage with a short term,
- no follow-up financing required.
The disadvantages include, in particular, the following points:
- limited flexibility,
- high total monthly burden,
- no additional payments (or early repayment fees),
- changing banks is effectively impossible,
- missed payments make the loan more expensive.
Who is this financing suitable for?
With this loan, you benefit from planning certainty and rapid repayment. However, due to the higher repayment, you bear a higher monthly burden. Therefore, you should have a secure and sufficiently high income to consider a fully amortizing loan. Since the burden also increases with the loan amount, other forms of financing are often more suitable for very large loans.
Monitor interest rate trends
Interest rate developments also play a major role. With such a loan, you save money through the faster repayment a a considerable sum in interest payments. However, the interest rate should fit the market environment. It is difficult to predict how construction loan interest rates will develop over several years. Nevertheless, you should monitor the trend.
When interest rates are falling, such a loan is not suitable, as the included fixed-interest period locks you into the currently higher market interest rate by comparison. Such a loan is particularly advantageous in a low-interest environment or when rising interest rates are expected. However, when interest rates are rising, banks will in turn factor a risk premium into the fixed-interest period. You should then weigh up whether the premium is justified over the entire term. If it is too high, it could result in an additional financial burden overall.
Advice recommended
You should generally seek advice when selecting real estate loans. Always obtain several offers. Some providers also specialize in advice that is free of charge for you. Such expert advice can be helpful in finding the best type of real estate loan and assessing the offers. This also includes full-repayment loans.