The first component is the interest charge which is calculated as a percentage of the debt. This interest rate can be fixed (as with a fixed rate mortgage) or variable (as with a variable rate mortgage or LIBOR-based mortgage).
The second component is the amortization payment. This portion of payments amortizes the loan, and makes up the difference between the interest charge and the full annuity.
Annuity payments remain the same throughout the mortgage term, but the portions of payments which are made up of interest and amortization payments may change. As mortgage debt is paid off and interest charges go down, the amortization payment increases accordingly. As the interest charge decreases, a larger portion of each repayment is used to amortize the mortgage – so the pace at which the mortgage is amortized normally increases throughout the mortgage term.
Example: You mortgage a home using an 800,000 Swiss francs annuity mortgage and agree to pay an annuity of 20,000 francs per year. An interest rate of 1% is charged during the first year, and a 2% rate applies during the second year. The first year, your 20,000-franc annuity payment consists of an 8000-franc interest charge and a 12,000-franc amortization payment. In year two your mortgage debt is 788,000 francs and your annuity payment is made of 15,760 francs in interest charges and 4240 francs in amortization payments.
Annuity mortgages differ from fixed rate mortgages with direct amortization because the size of repayments remains identical throughout the mortgage term even though the size of individual components varies. When you pay off a fixed rate mortgage using direct amortization, your regular payments normally decrease as your mortgage debt is amortized.
Annuity mortgages are no longer popular in Switzerland, although they are still offered by some Swiss banks. However, the current low-interest environment has revived interest in annuity mortgages.
The logic: Amortizing your mortgage as quickly as possible while interest rates are low can help you cut debt fast before interest rate climb again. Both annuity mortgages and directly amortized mortgages can be used to pay off mortgage debt. However, the tax benefits associated with indirect amortization continue to make it the preferred means of mortgage amortization in Switzerland.
More on this topic:
Interactive mortgage comparison
Mortgage calculator
Annuities explained
