There are three types of amortization that are applied in Spain and that differ significantly in their characteristics. The loan amortization conditions the amounts and the time of return of the money.
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Next, we proceed to explain what the French, German and American depreciation
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1. What is loan amortization?
Before addressing the different types of amortization, it is convenient to review some key technical concepts related to the loan amortization.
A loan is a contract by which a lender and a borrower agree to the temporary assignment of a defined amount of money.
The borrower agrees to repay the loan, along with additional interest, under the agreed terms and conditions.
Amortization refers to the process of total or partial payment of the contracted debt. In addition, when repaying any loan, three different concepts are paid:
– Principal capital. The amount of money borrowed.
- Interest. The price charged by the financial institution for lending the money.
– Commissions and other expenses.
One of the distinguishing features between the different types of amortization It is the way in which those three rubrics are distributed.
The calculations that are carried out to determine the distribution between capital, interest and commissions allow us to speak of French, German or American depreciation.
2. What is a loan amortization system?
There are different ways of approaching the progressive repayment of loans. The first dichotomy that arises is the choice between fixed or variable fees.
Certainly, they can be constant, decreasing or increasing, and the choice of one or the other entails the determination of the monthly amounts that will be paid to settle the debt.
The call amortization table is the key tool to manage this return. Collect the dynamics of payments, including:
– Calendar and dates of subscriptions.
– Amount of each installment.
– Amount corresponding to the amortization of the initial capital.
– Amount of interest paid.
– Balance pending return.
That is, the amortization table allows knowing how much you have paid and how much you have left to pay, as well as the final date on which the loan will have been fully repaid.
3. Loan repayment rates applied in Spain
Have you heard of the method of French amortization?
Do you know what the difference is with the German or American depreciation methods?
If you do not have basic notions about these methods, you will be blindly signing your amortization contracts.
The difference between these depreciation systems derives from how to deal with debts. Depending on the model applied, the final disbursement is significantly conditioned.
3.1. French amortization
Among the various types of amortization In Spain, the most common is the French amortization system.
Their main characteristic is that they apply fixed and constant installments throughout the repayment period, which allows the borrower to be certain of the amount that must be faced each time.
We consider it important to highlight that at the beginning of the amortization more interest is paid than at the end, since these are greater the greater the outstanding debt.
Stability is, therefore, the main advantage of this system, as it makes it possible to identify at any time how much has been paid and how much remains to be paid. To do this, it is only necessary to multiply the number of installments paid or pending by the constant amount of the installment.
However, the disadvantage of this system is that the actual repayment of the principal capital is made later in the repayment period, which usually means a superior generation of interest over time.
3.2. german depreciation
This amortization system uses decreasing installments, which means that as time passes, smaller amounts are paid.
In each installment, a fixed part is used to amortize the principal capital, while the rest depends on the accrued interest.
As the debt is paid off, the interest is reduced and therefore the final installment is also reduced.
The main advantage of this system is that, year after year, a proportional part of the nominal amount of the loan is eliminated, which helps to reduce the final amount of interest and make final installments more affordable.
However, a disadvantage of this system is that the initial fees can be so high that they are very difficult to bear.
3.3. American amortization
The American amortization system is less frequent in Spain and its use It is not usually recommended for loans to individuals.
It consists of making initial payments of interest only, followed by a final payment that includes the full amortization of the borrowed capital.
This system involves a higher computation of interest and, generally, payments are made on an annual basis.
It is important to note that there is no type of amortization better than another, but the choice depends on the particular needs of each specific case.
At WorkCapital we offer advice to make the best decisions, making available to our clients those financial products that best suit their singularities.
Feel free to contact us for more information.
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