Any mistakes in concluding a mortgage agreement can hit the budget. In order not to overpay banks, it is important to choose the right way to repay the loan. We tell you what is good about a differentiated payment
RBC-Real Estate has already written about the features of annuity payments, in which the amount of the monthly contribution does not change throughout the entire loan period. But it turns out to be a large overpayment of interest.
In this article, we are talking about a less common repayment strategy for borrowers — differentiated payments. Most banks themselves determine what the method of repayment of a mortgage loan will be. In Russian banks, this is usually an annuity scheme. And yet, some credit institutions leave this choice to customers. We explain what a differentiated payment is and how it is calculated.
What is a differentiated payment?
A differentiated payment is a loan repayment system in which the borrower deposits different amounts monthly, the amount of which decreases each time. The maximum financial burden falls on the first months after the mortgage is issued, and towards the end of the loan period, contributions become minimal.
The difference in the amount of payments is due to the fact that under a differentiated scheme, the so-called loan body (its amount excluding interest) is distributed over the entire period in equal shares, and interest is accrued on the balance on top of a fixed amount.
Since the principal debt is reduced by the end of the loan term, less interest is accrued — hence the changes in the amount of the monthly payment. For comparison, with an annuity, the amount of minimum contributions is always fixed, but the ratio of interest and principal changes. In the first months, the lion’s share of the payment goes to repay interest, while the borrower’s principal debt almost does not decrease. Only after the bank has received most of the required interest, the repayment of the principal debt begins. Thus, the final overpayment on the loan turns out to be significantly higher.
On the graph, you can see how, with differentiated payments, the amount of overpayments decreases in the process of debt repayment (Photo: credits.ru )
Annuity and differentiated payment: differences
1. Different calculation methods
The method of calculating an annuity mortgage is adjusted so that the monthly payments are the same. To do this, the amount that goes towards paying the principal and the amount that reflects accrued interest change every month. But the total amount to be paid regularly to the borrower will remain unchanged from month to month.
With a differentiated mortgage, the amount that goes to repay the principal is fixed at the same level. But the amount of accrued interest varies depending on the balance of the debt. Therefore, the monthly payments will be different each time.
You can understand the differences in methods using a mortgage calculator if you set the same loan amounts, the same terms and interest rates, but specify different types of mortgages — differentiated and annuity.
2. Different payment amounts
With an annuity mortgage, the monthly payment is constant, but with a differentiated one, it changes every time.
3. Different loan repayment costs
Due to different methods, the amount of interest accrued over the entire term of the mortgage will be higher with an annuity loan than with a differentiated one. Therefore, the total amount, which, taking into account the principal debt, will be returned to the bank, in the case of an annuity, will be higher.
Differentiated payments are a more profitable mortgage repayment strategy for borrowers (Photo: Rahabi Khan/Pexels)
How to calculate monthly contributions
Upon conclusion of the agreement, the borrower receives a payment schedule. If in the case of an annuity you need to remember only one digit, then with a differentiated scheme you will have to check this document regularly. You can also check the current amount of the mandatory payment at the bank’s office, through an ATM or by calling the contact center.
If desired, the payment amount can be calculated independently. To do this, it is most convenient to use a mortgage calculator or a specialized online service on the bank’s portal. A more time—consuming option is to calculate using the formula. It’s not that difficult, but it takes a lot of time.
The initial loan amount is divided by the term in months — this is how you get the basic amount of payment. Further, interest is added to it every month. To calculate them, the balance of the principal debt must be multiplied by the interest rate and divided by 12.
Calculation example
Let’s take an example of the difference in the calculations of annuity and differentiated payments. The final figures will be approximate, since different banks have their own conditions for the schedule and payment of contributions. But the calculation is usually the same. Let’s say you have issued a mortgage in the amount of 6 million rubles for ten years at a rate of 10% per annum.
Annuity payment
In this case, you will have to pay 79.29 thousand rubles to the bank every month. The final overpayment on the loan will amount to 3.51 million rubles.
Differentiated payment
According to the same initial data, but with differentiated payments, the monthly contribution throughout the entire loan period will drop from 100 thousand to 50.42 thousand rubles. The overpayment of interest will be half a million less — 3 million rubles.
With a differentiated scheme, you can calculate the amount of the mandatory monthly payment yourself (Photo: Khwanchai Phanthong/Pexels)
The pros and cons of differentiated payment
The main advantage of differentiated payments is tangible savings on interest. With an annuity, they are accrued according to a scheme that is more profitable for the bank. In the case of a differentiated repayment system, the borrower pays interest each time only for those funds that he actually used in the billing month. Since the loan body becomes smaller with each installment, deductions to the lender are also reduced with it. As a result, the principal debt decreases faster, and the final overpayment turns out to be significantly less than with an annuity. This is best seen with large amounts and mortgage terms.
On the other hand, differentiated payments are less accessible. This scheme is more suitable for people with high earnings, since the solvency of potential borrowers is assessed more strictly. The confirmed income should be on average about 20-25% higher than in the case of an annuity. This is due to the fact that when approving a loan, the bank starts from the first months, which account for the maximum monthly payments. Although contributions may be halved in the repayment process, under a differentiated scheme, borrowers are approved for smaller amounts.
Another disadvantage is the constantly changing amount of monthly contributions. Because of this, the borrower has to constantly check the payment schedule and specify how much money will be required to be deposited in the next billing period. In addition, family budget planning is becoming more complicated.
The main advantage of differentiated payments is saving on interest (Photo: Andrea Piacquadio/Pexels)
Who is suitable for a differentiated mortgage
Despite the benefits of differentiated payments, you need to choose a repayment scheme based on your goals and current financial capabilities. A differentiated schedule allows you to save well on interest, but it is not suitable for everyone. It is better for people with low earnings to choose an annuity, otherwise the first payments may be unaffordable for them. If the borrower expects to receive a large loan and does not plan to repay it ahead of time, differentiated payments will also not have the desired effect.
If the budget can cover the initial payment and sufficiently large subsequent payments, a differentiated mortgage will be the best option. Experts recommend it to people with high earnings and those who have additional sources of income that will allow them to maintain their usual standard of living during the period of the highest credit burden. You can save even more if you pay off the mortgage ahead of schedule. This is beneficial, since in the case of a differentiated scheme, interest is not repaid immediately, but distributed throughout the entire loan period.
Which banks have differentiated mortgage payments
In Soviet times, differentiated payments were the only possible option for repayment of loans, so this scheme is often called a classic one.
Unfortunately, it is almost not found in the Russian mortgage market today. It is much more profitable for lenders to make annuity payments, since in this case they receive interest almost immediately. Only a few allow borrowers to determine the repayment procedure themselves. When applying for a mortgage, two schedules are drawn up so that the client chooses the most profitable one for himself.
Only a few banks are allowed to determine the repayment procedure for borrowers independently. When applying for a mortgage, the client can choose the most favorable payment schedule (Photo: Floriane Vita/Unsplash)
Some credit institutions also use both payment schemes, but their “classics” apply only to consumer loans. You can learn more about loan programs in the relevant sections on the websites of credit institutions.
Employees of these banks take into account the preferred repayment method for the client, but the final decision is made after reviewing the application, checking the credit history and analyzing the financial condition of the potential borrower. Before making a choice, we recommend comparing as many options and offers from banks as possible.
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