Author Topic: How to choose redemption amount in annuity loans  (Read 279 times)

Dwarfthrower

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How to choose redemption amount in annuity loans
« on: January 22, 2018, 11:26:57 AM »
Hey Guys,

right now I'm working on getting my expenses down for retirement in 12 years. I am going for my first rental purchase this year. Since I am sitting an Europe things are rather different. And translating everything doesn't help either.

The real Estate market here is on fire. Most houses and Flats are about 20 to 25 times the annual rent.
Thanks to hordes of students in desperate need of housing in my hometown small flats do work fine.

Real Estate income is taxed high here. In my cases 42%. I am allowed to deduct all necessary costs(Heat, taxes, interest, maintenance, driving and so on).
We are using fixed rate annuity loans.
That means I have choose a redemption percentage. So n% of the loan will be paid off in year one.
The monthly payment is this redemption part plus the interest. Since the rate is fixed I will build more equity every month while the interest part gets smaller fast.

Since this has a huge impact on my taxes due to the diminishing interest, I have trouble calculating Returns.

My example:
Small Flat 60.000 plus 5k closing cost.
3840 yearly net rent (plus side costs like heat, sewer inspections, trash Service, Furnace Service, Snow removal and so on.)

If I finance 100% and only invest the closing cost it is cash flowing after taxes:
  • 1 % inital redemption: 1000 bucks year one, decreasing due to higher tax load
  • 2 % inital redemption: 600 bucks year one, decreasing
  • 3 % initial redemption: -20 bucks year one, decreasing
  • 4 % initial redemption: -600 bucks year one, decreasing

Of course a higher initial redemption will build equity way faster while a loan with 1% redemption and low interest(1,7%) takes forever to pay off.
Interest is fixed for 10 years.
So I have 3 options:
  • 1% redemption, invest cash flow in ETF(and pay 25 % taxes on capital gains, but this could change to 42%) and pay off the 52.000 balance in a lump after 10 years
  • 2% redemption, same strategy but less cash flow and only 45.000 balance left after 10 years
  • 3 % redemtion, have to pay a little additional taxes every year and only 39.500 blance left in 10 years.

Since my savings rate allows me to pay this off in 4 years if I need to, I should not worry too much. But I do.
How would you approach this learning experience?
« Last Edit: January 22, 2018, 11:29:07 AM by Dwarfthrower »