Types of Loans

In Germany as well as in the USA there are two basic types of loans. Fixed Rate Mortgage (FRM) and adjustable rate mortgage (ARM). The big advantage of FRMs is that they provide a bigger planning reliability. Furthermore it is possible to lock in good conditions. The security is bought from countries with interest charges.

ARMs on the other hand, are cheaper in low-interest rate phases than FRMs. If the prime rate is rising, the costs of financing via ARMs rise as well. One way to avoid the burden of an increasing prime rate, a cap should be negotiated. It can be considered as an airbag. If the prime rate goes up, the cap comes into play and fixes the interest rate at a previously defined level.

An annuity loan is very popular in Germany. With this method, the redemption rate is fixed, only its composition of interest part and amortization part changes over time. The advantage is again with a high planning reliability because deviations over time can be ignored.

In the USA, another type of loan is preferred. Some German drivers might have heard of the Balloon Loan. The redemption rate is rather low, but the worse is yet to come. At the end of maturity a very high payment – balloon payment – is due. The – in most cases necessary – follow-up financing is usual far more expensive than the initial financing. This type of loan contains the risk of burning the candle at both ends, financially speaking, and lose sight of the liabilities.