Annuity loan: the instalment stays the same, you decide the term.

How an annuity loan works

The annuity loan is named after the instalment with which it is repaid. The annuity is a constant payment, usually monthly, made up of two parts: interest on the current outstanding balance and repayment, which reduces the debt.

The instalment is fixed when the contract is signed, using two percentages: the borrowing rate (Sollzins) and the initial repayment rate. Both refer to the original loan amount and are added together. At 3.5 per cent interest and 2 per cent initial repayment, the annual instalment is 5.5 per cent of the loan amount, spread over twelve monthly payments. As a formula: annual instalment equals loan amount times (borrowing rate plus initial repayment rate). Our mortgage calculator runs this with your own figures, including the balance after the fixed-rate period and the term until full repayment.

Because the instalment stays the same and the balance falls with each payment, the ratio shifts. In the first instalment of this example, around 64 per cent is interest and 36 per cent repayment. After five years it is 57 to 43, after ten years repayment exceeds interest for the first time, at around 49 to 51. This is the effect of interest saved: whatever the bank receives less in interest goes automatically into repayment.

This leads to a property missing from many product descriptions. The early years are the most expensive. Precisely where most borrowers choose the lowest repayment rate to keep the instalment small, the loan works least for them.

The initial repayment rate decides the term

The interest rate decides what the loan costs. The initial repayment rate decides how long it runs. How strong this lever is shows in a worked example with an assumed borrowing rate of 3.5 per cent and monthly payments. All values are shown as a percentage of the original loan amount, so they apply to any loan size.

Assumption: borrowing rate 3.5 per cent over the entire term, monthly instalment, no special repayments. ME Finance calculation, rounded.

Two percentage points more instalment, from 4.5 to 6.5 per cent a year, almost halve the term. The difference in the balance after ten years is 24 percentage points of the loan amount. That is exactly the amount that is no longer up for renegotiation when the first fixed-rate period ends.

Many German banks now require a minimum repayment of 2 per cent, and some grade the interest rate accordingly. The household budget sets the upper limit. A sensible repayment rate is therefore not a rule-of-thumb percentage, but the highest instalment that still works in a year with repairs and running costs. How equity helps here is covered in our guide to equity in German mortgages.

The outstanding balance at the end of the fixed-rate period

An annuity loan is almost never repaid by the end of the first fixed-rate period. Ten or fifteen years of fixed interest are common, with a total term of twenty to forty years. A new rate is agreed for the remaining balance, and nobody knows that rate today.

What that means shows in the continuation of the example with 2 per cent initial repayment. After ten years, 76 per cent of the loan amount is outstanding. If the instalment stays the same, the remaining term depends solely on the follow-on rate:

Assumption: start at 3.5 per cent interest and 2 per cent repayment, new rate after ten years with an unchanged instalment. ME Finance calculation, rounded.

In this example, one percentage point more on the follow-on rate costs almost three extra years. If you want to keep the term instead, you pay a higher instalment. One of the two always moves.

The law gives you some lead time. Under § 493 (1) of the German Civil Code the bank must tell you no later than three months before the end of the fixed-rate period whether it is prepared to agree a new rate, and state the rate it offers. Three months is tight for a market comparison. If you want to act earlier, you can lock in the follow-on rate years in advance with a forward loan. How long the fixed-rate period should be from the start is covered in choosing the fixed-rate period.

Annuity loan, fixed-repayment loan and interest-only loan

The annuity loan is the standard form, but not the only one. The difference lies in how interest and repayment are spread over time.

• Annuity loan. Same instalment, falling interest share, rising repayment. Predictable for the household budget, with slow debt reduction in the early years.
• Fixed-repayment loan (Tilgungsdarlehen). The same repayment amount in every instalment, with interest on top. The instalment is highest at the start and then falls. Less interest overall, but a much higher initial burden. Rare for owner-occupied homes.
• Interest-only loan (endfälliges Darlehen). Only interest is paid during the term, and the loan is repaid in one sum at the end, often via a home savings contract or an insurance policy. Expensive, because the debt never falls, and mainly used for let properties for tax reasons.

A special form is the full-repayment loan (Volltilgerdarlehen). It is an annuity loan in which repayment rate and fixed-rate period are chosen so that the debt is fully repaid when the period ends. The follow-on risk disappears, but the instalment is high. Banks often grant an interest discount for this structure.

Special repayments, rate changes and the ten-year termination right

The fixed instalment is the advantage of the annuity loan and at the same time its limitation. What can be changed during the fixed-rate period is set out in the contract, not in the law. Three clauses are therefore worth a look before signing.

• Special repayment (Sondertilgung). Additional payments outside the instalment, usually capped at a percentage of the loan amount per year. Every special repayment reduces the balance immediately and shortens the term.
• Repayment rate change. The right to change the repayment rate, and with it the instalment, during the fixed-rate period, often once or twice. Valuable for families whose income will foreseeably change.
• Repayment holiday. Some banks allow individual instalments to be suspended, for example during parental leave. The term lengthens accordingly.

Regardless of the contract, a statutory termination right applies. Under § 489 (1) no. 2 of the German Civil Code you can terminate a loan with a fixed rate ten years after full disbursement, with six months' notice. With a fixed-rate period of fifteen or twenty years, that is an exit without an early repayment charge (Vorfälligkeitsentschädigung). If you exit earlier, for example when selling the property, you will usually pay it.

Flexibility has a price. Some banks charge a small interest premium for high special repayment rights and repayment rate changes. Whether that pays off depends on how likely you are to actually use them.

You are entitled to the amortisation schedule

An amortisation schedule shows, instalment by instalment, how much is interest, how much is repayment and how high the balance is after each payment. For an annuity loan it is the most important document next to the contract, because it states the balance at the end of the fixed-rate period in black and white.

You do not have to calculate it yourself. Under § 492 (3) sentence 2 of the German Civil Code a borrower with a loan that has a set repayment date can request an amortisation schedule under Article 247 § 14 of the Introductory Act to the Civil Code at any time. That applies before signing, as a basis for decision, and during the term, for example before a special repayment or the follow-on financing.

When comparing several offers, the schedule helps more than the rate alone. Two offers with the same effective annual rate but different repayment lead to very different balances. They only become comparable once instalment and balance at the same point in time sit side by side.

What to take away from this article

• With an annuity loan the instalment stays the same, its composition shifts from interest to repayment.
• The initial repayment rate sets the term more strongly than any rate difference between two banks.
• An outstanding balance almost always remains at the end of the fixed-rate period, and it is charged at tomorrow's rate.
• Special repayments and rate changes are a matter of contract. The ten-year termination right is in the law.
• You may request the amortisation schedule at any time. It is what makes offers comparable in the first place.

ME Finance is not a bank and does not sell a product of its own. We compare offers from over 500 banks and lending institutions and calculate repayment and balance for your situation. How we work is set out on the page on mortgages, and for existing loans on the page on follow-on financing. You can send us your key figures via the non-binding enquiry.