Favorable building loan interest, long term
In the current low-interest phase, the hunt for the lowest possible interest rate has begun. Finally, it is common knowledge that low interest rates also result in cheap loans. Every borrower would like to save where he can and would rather do it in his own pocket than pay the bank high mortgage interest. However, low construction interest rates can make you pay off a loan very slowly compared to higher interest rates, which means that you ultimately end up with higher interest costs. This phenomenon is called the redemption paradox. But there are ways to counteract it.
The repayment paradox describes a phenomenon with annuity loans: If the interest rate for offer A is lower than for offer B, but the repayment is the same, the remaining term of the loan increases. So if you have two mortgage offers with different interest rates and you choose the one with the lower interest rate with repayment yourself, accept that you will have to pay the mortgage a few years longer. The reason lies in the nature of annuity loans.
These loans are structured in such a way that the monthly installment remains the same throughout the years. It consists of an interest component and a repayment component. The interest portion goes to the bank. You pay him for the bank to lend you the money at all. The repayment portion goes into the payment of your remaining debt. Because the interest portion is always counted towards the amount of the remaining debt and this residual debt decreases continuously, the interest portion also decreases. Within the monthly rate, the situation shifts over the years: the interest component continues to decrease, the repayment component continues to increase, while the rate itself remains the same. A pictorial example: Suppose your rate is 1,000 dollars from the start. At the beginning of your mortgage lending, 300 dollars flow into the interest and 700 dollars into the repayment. At the end of your mortgage lending it is only 80 dollars interest and 920 dollars repayment.
Repayment paradox means: In the case of a loan with an interest rate that is lower from the start and the same repayment rate, it takes longer for the ratios to shift within the rate in favor of repayment, the interest component declines more slowly and the repayment component increases more slowly. As a result, it will take you a total of longer to completely pay off your remaining debt. And you have to accept higher interest costs over the years.
Annuity loan with different interest rates with repayment
You can clearly see this example: at an interest rate of 1.2 percent, the monthly rate of your mortgage lending is significantly cheaper (980 dollars instead of 1,073.33 dollars), but the remaining debt is higher in the end, and it will take a total of one and a half years longer until you have paid off the entire loan. Let us now compare again what would happen if, with the lower interest rate, you increased the repayment a little higher from the start, namely to 3.5 percent per year:Table: Annuity loan with higher repayment in comparison
Here you can see: With an initial repayment of 3.5 percent instead of 3 percent, you can counteract the repayment paradox. Because then you can choose the mortgage with the lower interest rate and still finish the remaining debt faster, namely after 24 years and 5 months instead of only after 26 years and 7 months. The rate is roughly the same as for the offer with the higher interest rate, but you have paid off much more debt after 10 years and are now only at 175,932.78 dollars instead of 188,972.87 dollars.