Equal or decreasing instalments – what is the difference and which to choose?

When taking out a mortgage to buy a property, for example in Sosnowiec, we need to realise how big a commitment we are dealing with. We should also remember that when repaying the debt to the bank, we have two repayment options. We can choose equal or decreasing instalments. How do they differ, which will be more suitable for us, and why? We explain these issues below.

Equal or decreasing instalments? A little theory

Borrowers generally do not realise that when paying back the borrowed money they can do so in two different ways – using equal or decreasing instalments. To understand the differences between them, it is worth taking a closer look at a little banking theory. Most of us do not realise that the interest rate, the commission and the financing period are not the only variables that characterise banking products. We should remember that a loan instalment consists of a capital part and an interest part. The former is the amount paid to the bank towards repaying the debt, and the latter is the financial institution's remuneration. Let us add that the amount of interest depends in turn on the interest rate of the loan and the WIBOR reference rate (EURIBOR or LIBOR, depending on the currency in which the loan is granted).

What characterises equal instalments?

Bearing in mind what was written above, it should be stressed that equal instalments are the most popular among bank customers. The repayment system is in this case safer for the bank, and in the initial phase of repayment the borrower bears lower costs than with a decreasing instalment. The name does not mean, however, that the size of the instalments will stay unchanged for years. It will change along with fluctuations in the WIBOR rate, which, with repayment over many years, is unavoidable. In addition, an equal instalment consists mostly of interest, so you may get the impression that at first the debt hardly shrinks over time. This happens because the interest (the bank's remuneration) is higher than the capital we repay towards the debt we have taken on.

READ ALSO – WHAT DOCUMENTS ARE NEEDED FOR A MORTGAGE?

Decreasing instalments – what sets them apart?

When we choose equal instalments, the assessment of our creditworthiness is calculated in our favour and such a loan is easier to obtain. With decreasing instalments the assessment process is more restrictive. The initial stage of repaying the loan places a heavier burden on the borrower's budget, because the decreasing instalment is then higher than at a later stage (the difference can be as much as several dozen per cent). The capital part of a decreasing instalment is calculated as the amount of the liability divided by the number of instalments. This means that for a loan of 240 thousand PLN repaid over 10 years, the capital part of the monthly instalment will be 2,000 PLN. In this case interest is calculated on the capital remaining to be repaid. With each month this amount will be 2,000 PLN smaller, but only on the assumption that WIBOR does not change during that time.

READ ALSO – A MORTGAGE FOR RETIREES AND DISABILITY PENSIONERS

Which type of instalment should you choose?

Taking into account the properties of both kinds of instalment, it is worth considering which repayment system to choose. It is best to carry out such calculations using an example. Let us take an amount of 240,000 PLN. Suppose the loan period is 30 years and the interest rate is 5.00%. In this case (for equal instalments) the first one will be 1288.37 (interest 1,000 PLN, capital 288.37 PLN), while the 360th instalment will cost 1288.38 PLN (interest 5.35 PLN, capital 1283.03). Here, as we can see, the bank's remuneration, that is the amount of interest, falls over time. With decreasing instalments the situation looks somewhat different. The first instalment will total 1666.67 (interest 1,000 PLN, capital 666.67), while the last will be only 669.45 (interest 2.78, capital 666.67). This means that with decreasing instalments the amount of interest, that is the bank's remuneration, falls significantly over time. Let us add that the total amount to be paid back to the bank with decreasing instalments is 420,499.72 PLN. With equal instalments we have 463,814.24 PLN to repay. The difference is 43,314 PLN in favour of decreasing instalments.

On the assumption that WIBOR does not change over the years, decreasing instalments, as we can see, are decidedly more advantageous. By choosing them you pay less, but you need better creditworthiness. Any questions about the ins and outs of this subject can be cleared up by consulting the specialists at REMAX Gold, who will explain all the complexities of financing a property purchase.