Annuity vs equal principal payments: which is cheaper

Two ways to repay a loan

Every loan payment has two parts: principal (the part of the borrowed amount you pay back) and interest (what the bank charges for the use of the money). Interest is calculated every month on the remaining balance. The difference between the two schedules is how the bank splits your payment between these parts.

Annuity payment: the same amount every month for the whole term. At the start most of the payment goes to interest, and towards the end most of it goes to principal.
Equal principal (declining) payment: the principal is split into equal parts and interest is charged on the remaining balance. So the payment gets smaller every month.

Example: UAH 100,000 at 24% a year for 12 months

Take a one-year loan of UAH 100,000 at 24% a year. That is 2% a month on the remaining balance. To keep it simple, no fees or insurance.

With equal principal payments, the principal is divided by 12: UAH 8,333 every month plus 2% of the remaining balance. The first payment is 8,333 + 2,000 = UAH 10,333, the last is 8,333 + 167 = UAH 8,500.

Payment schedule, UAH
Month	Annuity: payment	of which interest	Equal principal: payment	of which interest
1	9,456	2,000	10,333	2,000
2	9,456	1,851	10,167	1,833
3	9,456	1,699	10,000	1,667
4	9,456	1,544	9,833	1,500
5	9,456	1,385	9,667	1,333
6	9,456	1,224	9,500	1,167
7	9,456	1,059	9,333	1,000
8	9,456	891	9,167	833
9	9,456	720	9,000	667
10	9,456	545	8,833	500
11	9,456	367	8,667	333
12	9,456	185	8,500	167
Total interest		13,472		13,000

With an annuity the total interest is UAH 13,472; with equal principal payments it is UAH 13,000. A difference of UAH 472 on a one-year loan of 100 thousand looks small. But it grows with the term and the rate: on a 15-20 year mortgage the gap between the two schedules can reach hundreds of thousands of hryvnias.

Why an annuity costs more in interest

Look at the first months: with equal principal payments you repay UAH 8,333 of principal every month, while with an annuity you repay only UAH 7,456 in the first month, because interest takes the rest of the payment. The debt shrinks more slowly and interest is charged on a larger balance. An annuity is essentially the price of evenness: you pay less at the start but keep the borrowed money for longer.

Comparison: which to choose

	Annuity	Equal principal
Payment size	the same for the whole term	larger at first, smaller later
Burden at the start	lower	higher
Total interest	higher	lower
Budget planning	simpler	you need to plan for the peak first months
Where you see it	most consumer loans, car loans, instalment plans	more often in mortgages and business loans
Suits	a stable but modest income	an income with room to spare and a wish to pay less interest

Choose equal principal payments if you can comfortably handle the largest, first payment and want to minimise interest. A quick check: the first payment should take no more than a third of your take-home income, and after it you should still be able to put money into an emergency fund.

Choose an annuity if an even, predictable payment matters to you or the first equal principal payment is too heavy. Especially if you plan to repay early: then much of the difference in interest disappears.

How early repayment changes the picture

Extra payments go towards principal, so they reduce the balance on which future interest is charged. With an annuity, the bank usually offers two options: shorten the term or reduce the monthly payment. You can compare both options for your own loan in the loan calculator: it shows how much interest each one saves.

Shortening the term almost always saves more. Lowering the payment makes sense if you need to ease your budget. One key rule: the earlier you make the extra payment, the more you save, because at the start of an annuity the payments are mostly interest.

Before repaying early, check the contract: is there an early repayment fee, and how exactly does the bank recalculate the schedule? And if you have savings that earn less than the loan costs, it pays to send them towards the debt. The exception is your emergency fund: leave it alone.

What else to check in the contract

The payment schedule is only one of the terms that shape the real cost of a loan. Before signing, check:

Fees. A one-off arrangement fee or a monthly service fee can make a loan with a lower rate more expensive than one with a higher rate. That is exactly why you compare the real annual interest rate.
Insurance. Find out whether it is mandatory, how much it costs and whether you can choose the insurer yourself.
Rate type. A fixed rate does not change during the term. A variable rate is tied to an index and can go up, and then so does the payment.
Penalties. How much a few days' delay costs and when the data is passed to the credit bureau.
Early repayment terms. Is there a fee, do you need to notify the bank in advance and how exactly is the schedule recalculated?

Most important of all: your payments on all loans together should not take such a share of income that you can no longer save even a small amount. How to split income so there is enough for both debt and savings is covered in our article on the 50/30/20 rule.

In short

Annuity: equal payments; equal principal: larger first, smaller later.
A UAH 100,000 loan at 24% for a year: annuity UAH 9,456 a month and UAH 13,472 interest; equal principal UAH 10,333 → 8,500 and UAH 13,000 interest.
Equal principal costs less in interest; an annuity is easier on the budget.
The difference grows with the term: for a mortgage it can be substantial.
Early repayment with a shorter term saves the most, especially at the start of the loan.
Compare loans by the real annual interest rate, not the nominal one.

Sources

The calculations in this article are illustrative. Your actual schedule depends on the contract terms, fees and insurance. Before signing, compare the real annual interest rate and the total cost of the loan. This article is not financial advice.