How to Pay Off a Loan: 8 Tips, Amortize, Interest, & Credit


Do you have a loan or are you considering taking out a loan? Then it is important that you understand how the amortization affects your borrowing costs and your finances in general.

Here I go through all the facts and smart tips needed for you to be able to handle the repayment of your loans in the best way.

So, how do you pay off a loan?

There are two different types of repayment; straight amortization and annuity. With straight repayment, which is most common, you repay your loan with an equal amount each month. In addition to the repayment, you also pay interest each month, which is a percentage of the loan amount you have left to repay. In straight amortization, you pay different amounts of interest at each payment occasion because your debt decreases.

In the case of an annuity, you instead pay a certain amount each month, which includes both interest and amortization. The total interest cost on straight amortization will be slightly lower than for an annuity loan, which is due to the debt on which the interest is calculated falling faster.

What is amortization?

Repayment of loans is called repayment. The banks’ repayment requirements look different for different loans and are based on factors such as repayment period, type of loan and total amount.

Amortization and interest are paid together, usually monthly or quarterly.

What is an amortization requirement?

All loans must be repaid at some point. But the conditions for the repayment, ie the amortization requirement, vary. On private loans and high consumer loans, the requirement is usually that the installments must be made monthly.

Amortization-free loans, which are usually associated with housing transactions, mean that the entire amount is repaid only when the term has reached its end.

When you buy a home, you only repay the loans when you sell it.

But the amortization requirements for new housing loans have been tightened, so completely amortization-free loans are rare at present.

When is it good to have amortization-free loans?

An amortization-free loan can seem tempting, as you get more in your wallet every month, but it is always better to repay if you have the opportunity because otherwise you will continue to pay interest even though the debt does not decrease.

The only time you should consider amortization-free is if you end up in a situation where there is no other way out.

For example, if the alternative to amortization-free would be to have to take out a new loan in order to be able to repay current debts.

Why amortize?

Unlike the interest rate, which is the bank’s cost for your loan, the amortization can be seen as a saving given that you invest in something that can retain or increase its value.

If, for example, you use a loan to invest in an apartment that you then sell for the same amount that you borrowed from the bank, you will in principle get back the money you have already repaid when the loan is repaid.

In addition, prudent repayment and low loans look good in the eyes of the banks, which gives you better opportunities to take out new loans if required.

8 tips when borrowing money

1. Make a budget

When you are about to borrow money, whatever it is, it is a good idea to make a proper financial calculation.

It is a good way to get an overview of your own finances and get an idea of how much you can and need to borrow, and that you will be able to repay the loan.

2. Choose the right kind of loan

There are several different types of loans. Mortgages, private loans, car loans and member loans are examples of different types of loans, which have different interest rates and requirements linked to them.

It can be good to collect your loans from a bank to get a good overview and a possible opportunity to lower your interest rate and get a lower monthly cost.

A rule of thumb is that the better security you have for your loan, the lower the interest rate you can get. This is why mortgages have lower interest rates than, for example, private loans.

Most often, the loans that do not require any security have variable interest rates, which means that it can change over time.

The interest rate is usually higher for these types of loans. In some cases much higher.

3. Interest and effective interest

The interest rate is the price tag that the lender sets to lend money to you. The interest rate must cover the cost of inflation, the risk the lender takes when it lends money and the loan is non-repayable, and a return for the lender.

You probably recognize the term interest-free installments.

Today, many retail chains and other players offer this to their customers and use it in their marketing. However, it is very important to keep in mind that there may still be fees, for example notification fees, which make the purchase more expensive.

In some cases, a loan can be completely interest free if you repay it within a set time.

But if you have not repaid the loan, then you have to pay an interest rate that is often very high. Different loans are structured in different ways with different fees.

Therefore, as a customer, you need to keep track of what the effective interest rate actually is. Effective interest means the total cost of the loan, including all fees (for example, notification fees and set-up fees).

You should always demand to know what the effective interest rate is, and it must also be stated in the seller’s marketing.

4. Credit check

In order to be granted a loan, the lender assesses the probability that you can actually repay the loan.

That assessment is based on various things, including creditworthiness and repayment ability.

5. Creditworthiness

Your credit rating is determined by several factors.

It can be, for example, how many loans you already have, what you have borrowed for, how often you have applied for a loan, if you have repaid the loans on time, if you have any payment remarks, how old you are and more.

6. Refundability

Your repayment ability is simply about your ability to repay the loan.

Here you look at, among other things, your income, your employment, your marital status and your type of home.

The better your ability to pay is judged to be, the easier it is for you to be granted a loan.

7. Credit information

To check the above and that you have the opportunity to pay interest and repayments on your loan, the lender must take a credit report.

It is required for all types of loans.

8. Amortization

A loan must sooner or later be repaid. If you buy a home, your amortization is calculated based on how much you borrow in relation to what the home is worth and your income.

• Mortgages over 70 percent of the value of the home must be repaid at least 2 percent per year.
• Mortgages over 50 percent up to and including 70 percent of the value of the home must be amortized by at least 1 percent per year.
• In addition to this, you who borrow more than 4.5 times your annual gross income must repay an additional 1 percent of the total loan amount.

As I mentioned before there are two different types of repayment; straight amortization and annuity.

Straight amortization, which makes you debt-free the fastest, means that:

  • You pay the same repayment amount to the bank every month
  • The costs for interest (a percentage of the total remaining loan amount) are high in the beginning, but decrease over time as you pay off the loan and the loan amount decreases.
  • You pay a higher total amount to the bank each month when you have just taken the loan and a smaller total amount when the loan is soon repaid.

Annuity loans, also called “annuities”, mean that:

  • You pay the same total amount (amortization + interest) every month during the entire loan period.
  • You repay a small amount in the beginning which then increases gradually over time. When the debt decreases and the interest rate falls, the amortization amount is adjusted by allowing you to amortize more instead. You thus even out your loan during the repayment period.
  • Interest costs are high in the beginning but fall as the loan amount falls. In other words, the amortization portion increases over time while the interest portion decreases over time.

Conclusion

How much to repay?

You should repay as much as you can, as each repayment reduces both the debt and your interest charges. By amortizing, you protect your personal finances against future interest rate increases.

Today, when interest rates are at a record low, it can be a good idea to set aside money or make extra repayments to prevent a possible interest rate fluctuation.

Kevin

Hi, my name is Kevin and I am a weightlifter, now part time blogger. Keep in mind that I dont have any fancy degrees or operate some high-end business company. I am just a dude from Sweden who loves to learn new things, especially new things on how I can inqrease my wealth. And now I have the opportunity to share that knowledge back to you.

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