Equal or decreasing installments – which ones to choose?
Taking a mortgage, sooner or later we will face a dilemma related to what form we intend to pay back. You can choose either equal or decreasing installments. Which ones we choose will affect both our creditworthiness and the total cost of the liability
What does the loan installment consist of?
This is the capital and interest part. The first concerns how much we borrowed from the bank. Each repayment reduces the debt balance. In turn, the interest part illustrates how much the bank will earn on our loan, it is the remuneration for the financial support provided.The amount of interest is related to the interest rate on the loan. The interest rate on the loan consists of the margin and reference rate.
The reference rate for loans in native currency is WIBOR, for loans taken in euros – EURIBOR, and for loans in US dollars and Swiss francs – LIBOR. Exceptions to this rule are fixed rate mortgages, but they are very rare.
Equal installment – basic information
Equal installment is most often chosen by borrowers. The reason for its popularity is, among others that it is perceived by banks as less risky. It also has a significant impact on creditworthiness. It may for example turn out that we will receive a cash injection only if we decide to pay back the loan in equal installments.
However, we should remember that even when choosing an equal installment, we must take into account that its amount will not remain the same throughout the duration of the contract. This would only be possible if the WIBOR rate also remained unchanged. However, this is unlikely. Therefore, you should be aware that each increase or decrease in the WIBOR rate will translate into the amount of our monthly installment.
Decreasing installment – what is it?
Although the decreasing installment is cheaper than the equal installment, few future borrowers can afford it. First of all, especially at the beginning, the decreasing installment places a much bigger burden on the household budget. Secondly, it requires much more creditworthiness than an equal (average) installment.
Like an equal installment, a decreasing installment consists of the principal and interest parts. The capital part for this type of installments is calculated by dividing the loan amount by the number of installments. Interest is calculated on the basis of capital decreasing each month. Thus, the decreasing installment translates into a lower cost of commitment, although at the very beginning it is a much larger expense.
In her favor is also the fact that from the beginning we pay back a significant part of the borrowed capital, which each time reduces the balance of our debt. Theoretically, with a decreasing installment, the amount of each subsequent payment should be lower than the previous one, but this is not the rule. Here again, a lot depends on the WIBOR rate. If the WIBOR rate increases, the same will happen with our installment.
Equal and decreasing installment – find out the difference
Apart from the cost of debt service, what distinguishes an equal and decreasing installment is another way of calculating the installment amount.
Contrary to what may seem less complicated, there are decreasing installments. The capital part remains constant, the “only” amount of interest changes. Their amount depends on the WIBOR rate and how much we still have to pay. Although installments decreasing at the very beginning of the repayment is a significant expense, at the end of the loan agreement they will be only a small burden on the household budget.However, the amount of an equal installment is calculated using a rather complicated, mathematical formula.
Not just interest
What else we should consider when considering whether to choose an equal or decreasing installment are … our financial capabilities. As we have already emphasized, decreasing installments translate into lower cost of commitment, but initially they are much more severe for our portfolio than equal installments.
If we are not sure whether we can afford a loan repaid in the form of decreasing installments, choose equal installments. In addition, if we decide on equal installments, we will be able to borrow a higher amount from the bank. Decreasing installments are recommended for people with higher incomes and better credit standing.
Choice of installment type and earlier mortgage payment
If you are going to pay back your loan early, check to see if there are any additional costs involved. In a situation where we are considering paying back the loan ahead of schedule, decreasing installments will be more beneficial for us.
Equal or decreasing installments? Summary
Every potential borrower will have to answer the question whether to choose an equal or decreasing installment. From an economic point of view, decreasing installments are a much better solution. Firstly, they are cheaper, and secondly, by paying installments in this form, we will pay your debt much faster. However, as we have already mentioned – not everyone can afford them. The main advantage of equal installments is, however, that thanks to them people with lower creditworthiness can also get funds to buy their dream property. The price we pay to pay for less wallet load will be the higher cost of the commitment.