As everyone knows, taking out a loan means borrowing from a credit institution a certain amount made available, the “capital”, which will then be reimbursed via a defined number of payments periodicals: the “deadlines”.
Declining balance, straight-line, reimbursement in fine… Among the many existing formulas, how to find your way around? Find out the differences and the exact terms of each type of credit amortization.
What is amortization of a loan?
A loan is said to be “amortizable” when its maturities include a part dedicated to the repayment of the capital borrowed (the amount actually loaned by your banker) and a part allocated to that of the interest calculated on the capital remaining due by the borrower. “Credit amortization” is then the progressive repayment, on each due date, of the capital borrowed.
When the reimbursement is made monthly, which is the most frequent case, we speak of “monthly payments”. If the reimbursement is annual, then these are “annuities”.
Good to know : a due date is made up of capital and interest, but also of the borrower insurance contribution that may have been taken out. In the majority of the amortization tables which accompany a credit contract, there is then a maturity date excluding insurance and an insurance maturity term included. To find out the total cost of a credit with insurance, you should therefore turn to the corresponding column.
How to calculate the amortization of a loan?
Considering the different types of amortization and the possibility of deferred repayment, it is not always easy to know where the payment of your loan is. It then becomes very useful to be able to refer to a depreciation table. Also called the installment schedule or repayment plan, an amortization table allows you to find out the share of the capital of the loan repaid and to calculate the amount of interest at each due date.
It also presents for each payment date the capital that would remain to be reimbursed to settle the loan in advance.
Calculating a amortization schedule can also be very useful in anticipation of taking out a loan. Taking into account various parameters such as the type and rate of borrower insurance associated with the loan or its duration, it presents the amount of each maturity, the share of capital, interest and insurance in the amount to be paid.
The total cost of interest and insurance on the entire loan also appears most often. It is therefore interesting to carry out several simulations to compare the amortization tables corresponding to several scenarios or even to visualize the consequences of a deferred repayment.
What are the types of amortization of a loan?
The proportion of interest and amortization of credit in a maturity varies over time, according to the offers of the lending organizations, but especially the method of amortization chosen by the borrower.
It is advisable to carefully select the amortization of a loan according to his personal situation, his heritage objectives, the type of credit made (mortgage, consumer credit, revolving credit…), the amount of the project, etc..
Amortization with constant maturities or progressive repayment of capital
This depreciation method is the most frequent. As the name suggests, it consists in repaying a credit via a certain number of installments, the amount of which is fixed. In other words, the borrower pays the same amount to his bank every month, from the beginning to the end of his repayment.
In the first installments, the interest repaid is higher than that of the principal. It decreases regularly while the share attributable to the repayment of capital increases.
In the event of redemption of a loan with fixed maturities, the preferred period is thus the first half of the life of the loan, when the interest paid is still substantial.
Constant amortization of capital or reimbursement on declining maturities
In the case of this type of amortization, also qualified as “linear”, it is no longer a question of paying the same amount at regular intervals throughout the duration of the loan but of repaying the same share of the capital borrowed each deadline. The interest being calculated in relation to the capital remaining due, their amount decreases with each due date.
The total sum to be paid each month, made up of a fixed part linked to the repayment of the capital and the part due to the interest, therefore decreases as the installments mature, hence the name “repayment with decreasing maturities”.
This depreciation method is very rarely offered to individuals and is intended more for businesses or local authorities. Indeed, it complicates the management of the monthly household budget.
Alternative depreciation possibilities
Depreciation at constant maturities and decreasing maturities is not the only possible method. It is for example possible to opt for a so-called modular amortization which, as its name suggests, allows the borrower to adjust his repayments according to the evolution of his budget.
The loan period may be reduced in the event of a large return of money or, on the contrary, increased in the event of financial difficulties. In connection, the monthly payment varies upwards or downwards.
Some banking establishments offer this possibility, for example, in all their home loan contracts: ask your bank advisor or a broker. Furthermore, such an addendum may be invoiced or be limited to a maximum number of operations per year.
Another alternative is to take out a loan in fine. This type of credit is strictly speaking depreciated. It provides in effect that the borrower pays all of the borrowed capital in one go, at the end of his loan.
Throughout the life of the loan, the customer will therefore only pay the interest generated by his credit, interest the amount of which will be the same at each due date since the capital due will remain constant throughout the loan. The total amount allocated to interest will therefore be higher than in the case of an amortized loan.
This type of loan is mainly used to finance real estate purchases for rental purposes. Including only the repayment of interest due to the credit, the maturities are shorter than those of an amortizable loan and they can moreover be deducted from the rental income of the borrower. In other words, the additional cost due to the interest on a loan in fine can be recovered for tax purposes.
On the other hand, it is generally necessary to provide solid guarantees, such as for example the pledge of a savings contract (life insurance, term account, etc.).
What is deferred depreciation?
The term “deferred amortization” designates a period, most often at the start of the credit, during which the borrower is exempt from the payment of his loan. This type of device is most often proposed in the case of a purchase, the realization of works or the construction of a house.
Indeed, it allows for example to avoid future owners from having to simultaneously assume their rent and a loan.
In the case of a partial deferral of payment, the debtor is only exempt from the payment of the part due to the capital. He must still pay the interest and costs inherent in his loan (for example, borrower insurance). During the entire deferred period, interest is calculated on the entire borrowed capital. The total amount of the credit will therefore be greater than in the absence of deferral.
In the case of a deferred total repayment, it is the entire maturity of a credit, that is to say not only the part due to the capital borrowed but also that linked to interest, which is carried over. The borrower will not begin to pay his loan until after the scheduled period. Please note, however, that a total deferral does not exempt you from paying insurance related to a loan. This type of deferral is very costly: the interest accumulated over its entire duration is added to the borrowed capital and in turn generates interest. In other words, while the capital remaining due remains unchanged at the end of a deferred partial amortization, at the end of a total deferred it will be greater than the capital loaned initially.
Credit in fine This type of credit is strictly speaking depreciated. It provides in effect that the borrower pays all of the borrowed capital in one go, at the end of his loan. Throughout the life of the loan, the customer will therefore only pay the interest generated by his credit, interest the amount of which will be the same at each due date since the capital due will remain constant throughout the loan.
The total amount allocated to interest will therefore be higher than in the case of an amortized loan. This type of loan is mainly used to finance real estate purchases for rental purposes. Including only the repayment of interest due to the credit, the maturities are shorter than those of an amortizable loan and they can moreover be deducted from the rental income of the borrower.
In other words, the additional cost due to the interest on a loan in fine can be recovered for tax purposes.
How to choose the method of amortization of your credit?
Choosing a progressive amortization loan offers unquestionable management facilities. The borrower will repay the same amount on each due date and will therefore be able to organize more easily.
In addition, the burden of the loan will be distributed equitably over the entire duration of the loan and the maturities at the start of the loan will be less onerous than in the case of constant amortization of the capital. If you want above all to distribute the financial effort attributable to your loan over time and not worry about anything during it, a loan with constant terms is the one for you.
For a loan of identical duration, the total cost of a loan with constant amortization of capital will be overall lower. Indeed, even if the maturities at the start of the loan will be heavier, it will make it possible to repay a larger share of the capital from the first years, which reduces the total interest generated by the loan since these are calculated from remaining capital.
However, there is very little chance that a banker will offer you a credit with decreasing maturities, in particular for a mortgage…
If you do not regularly look into the management of your credit does not put you off, the choice of a flexible amortization loan can then constitute an attractive alternative solution. Indeed, in addition to the comfort of being able to adapt the repayments according to your income, an upward modulation of the maturities will make it possible to increase the share of repaid capital and therefore to decrease the interest due calculated on the basis of this capital.
To go further: Get your amortization table to visualize the influence of the different components of your credit!